Mutual Funds Industry

A key distinction between a developed and a developing economy lies in their savings pattern. In an economically-matured country, people tend to save a higher proportion of what they earn, as compared to a developing country where average income is usually low and the marginal propensity to consume is high.
Our economy, plagued with high poverty, falls in the latter category. Saving is a luxury that is only afforded by a small proportion of the population - middle class (partly) and above. For an average Pakistani, saving (and investment) is still only confined to bank deposits or government bonds - but this mindset might change soon. Enter Mutual Funds.
A mutual fund allows many retail investors (big or small) to pool their money and entrust a fund manager to make prudent investments on their behalf. These investments are in accordance with the investor's guidelines pertaining to risk tolerance, among other things and are confined mostly to equities, money market instruments and bonds.
COMPARATIVE VIEW The global mutual fund industry is huge, worth $31.4 trillion (at 2014-end) as measured by total net assets, with US accounting for a whopping $15.9 trillion. Pakistan is relatively new to the game with most of its funds less than a decade old. The collective assets under management (AuM) of all asset management companies in Pakistan are little under Rs 500 billion.
For Pakistan, mutual funds AuM is still around 5 percent of total bank deposits. To put things in perspective, the assets that Indian MFs manage are 13 percent of the country's deposits, while Malaysia stands at 23 percent. Similarly, AuM as a percentage of GDP is under 2 percent for Pakistan, while for India and Malaysia, it is around 8 percent and 32 percent respectively.
The MF industry in Pakistan is still 'insignificant' relative to the regional economies, mainly because of its nascence. With a promising stock market, and a growing penetration of mutual funds, however, this gap is bound to shrink. From net assets (open-ended funds) of Rs 153 billion at the end of 2009, the tally currently stands at around Rs 425 billion - a compound annual growth rate(CAGR) of 19 percent.
The number of funds has kept increasing steadily over the years, with the number of asset management companies not changing significantly. The global recession was an inflection point for the mutual fund industry, as the AuM shrank 47 percent in 2009. Since then, the industry has been strong, mainly on back of the bullish stock market.
FUND CLASSIFICATIONS Mutual funds fall into three categories - open-ended, pension funds and closed-ended schemes. The predominant type - open ended, accounts for over 90 percent of total assets and due to its popularity, will be the center of attention in this article.
Open-ended mutual funds have no restrictions in the number of shares (units) its can issue, unlike a closed-ended fund. In the former type, investors can participate in the pool any time by purchasing the fund's units. When they wish to cash out, the open-ended fund will buy back these units. As of July-end, open-ended funds had AuM totalling Rs 425.4 billion, pension funds had Rs 14.2 billion and closed-ended funds, which have been declining in popularity, had Rs 16.6 billion worth of assets.
Within open-ended funds, there are four major categories that account for bulk of the assets: equity, income, money market and balanced/asset allocation funds. These categories can be further classified as normal (vanilla) or Islamic (Shariah-compliant) funds.
Equity funds contain more assets than any other category. The reason is simple - prospect of higher returns. The upbeat performance of KSE in the last four years has attracted more investors to equity funds. That being said, not all is rosy for them; these funds are characterized by high volatility and the investment horizon is longer than some might like.
By the end of last year, 29% of the assets managed by the industry were placed in equity funds (6 percent Islamic, 23 percent rest). Overall, Islamic equity funds boasted a 28.7 percent return in 2014, while the vanilla ones offered an impressive 47.3 percent return.
Money market funds also account for a major chunk of the pie. They attract investors who are not willing to take sizeable risk and their investment avenues consist of banks and T-bills. In 2014, the returns for Islamic and vanilla Money Market funds were 8.7 percent and 8.2 percent respectively.
Income funds are similar to money market ones, with the former also placing assets in Term Finance Certificates (TFCs) and Sukuks. Hence, income funds have a bit more volatility and the investment horizon is a bit longer as compared to money market funds. Last year, Islamic and vanilla income funds returned 8.7 percent and 9.3 percent respectively. Still, income and money market funds are pretty liquid investments that offer decent returns with low volatility. To compare, banks offer 5-6 percent on deposits.