1 Chapter Eight Mutual Funds

2 Mutual Funds Overview A mutual fund is nothing more than a collection of stocks and / or bonds. Mutual funds are financial intermediaries that pool the financial resources of investors and invest those resources in diversified portfolios of assets Initially a Mutual fund collect the funds from small investors, and when sufficient funds are gathered, then they are invested into the securities The fund is divided into the units and each holder is entitled to a proportionate share of the fund. Major fund disclosure document is called prospectus. Enjoy economies of scale by incurring lower transaction costs and commissions A mutual fund is nothing more than a collection of stocks and / or bonds. Mutual funds are financial intermediaries that pool the financial resources of investors and invest those resources in diversified portfolios of assets Initially a Mutual fund collect the funds from small investors, and when sufficient funds are gathered, then they are invested into the securities The fund is divided into the units and each holder is entitled to a proportionate share of the fund. Major fund disclosure document is called prospectus. Enjoy economies of scale by incurring lower transaction costs and commissions

3 Mutual Funds Overview A mutual fund is managed by a management company The portfolio of mutual fund is managed by a “Portfolio Manager” Shareholder services offered include free exchanges of investments between a company’s funds, automatic investing, check-writing, automatic reinvestment of dividends, and automatic withdrawals A mutual fund is managed by a management company The portfolio of mutual fund is managed by a “Portfolio Manager” Shareholder services offered include free exchanges of investments between a company’s funds, automatic investing, check-writing, automatic reinvestment of dividends, and automatic withdrawals

4 Historical Trends First mutual fund established in 1924 Advent of money market mutual funds in 1972 as investors looked for ways to earn market rates on short-term funds Tax-exempt money market mutual funds introduced in 1979 Special-purpose equity, bond, emerging market, and derivative funds exploded on the scene during the 1990’s First mutual fund established in 1924 Advent of money market mutual funds in 1972 as investors looked for ways to earn market rates on short-term funds Tax-exempt money market mutual funds introduced in 1979 Special-purpose equity, bond, emerging market, and derivative funds exploded on the scene during the 1990’s

5 History of Mutual Funds in Pakistan Mutual Funds were introduced in Pakistan in 1962, with the public offering of National Investment (Unit) Trust (NIT) Followed by the establishment of the Investment Corporation of Pakistan (ICP) in 1966, Currently there exists One open end (NIT) mutual fund in public sector. Twelve open-ended and Eighteen closed-ended mutual funds under private sector management Mutual Funds were introduced in Pakistan in 1962, with the public offering of National Investment (Unit) Trust (NIT) Followed by the establishment of the Investment Corporation of Pakistan (ICP) in 1966, Currently there exists One open end (NIT) mutual fund in public sector. Twelve open-ended and Eighteen closed-ended mutual funds under private sector management

6 A mutual fund can generate profits from three different sources, –Dividend –Capital Gains –Appreciation of Share Price A mutual fund can generate profits from three different sources, –Dividend –Capital Gains –Appreciation of Share Price Sources of Profit Generation

7 Types of Mutual Funds Open Ended Mutual Funds –Those where subscription and redemption of shares are allowed on a continues basis or at any time. –The price at which the shares offered for subscription and redemption is determined by NAV after adjusting redemption fee –The valuation used to be monthly or weekly, but now is almost universally done on daily basis –Open Ended Mutual Funds keep some portion of their assets in short-term and money market securities to provide available funds for redemption –A large portion of most open mutual funds is invested in highly “liquid securities”, which means that the fund can raise money by selling securities at prices very close to those used for valuation. Open Ended Mutual Funds –Those where subscription and redemption of shares are allowed on a continues basis or at any time. –The price at which the shares offered for subscription and redemption is determined by NAV after adjusting redemption fee –The valuation used to be monthly or weekly, but now is almost universally done on daily basis –Open Ended Mutual Funds keep some portion of their assets in short-term and money market securities to provide available funds for redemption –A large portion of most open mutual funds is invested in highly “liquid securities”, which means that the fund can raise money by selling securities at prices very close to those used for valuation.

8 Open end mutual funds Open Ended Mutual Funds –National Investment Trust (NIT) in public sector –Pakistan Stock Market Fund (PSM) –Pakistan Income Fund (PIF) –Unit Trust of Pakistan (UTP) –UTP Islamic Fund –United Money Market Fund (UMMF) –Dawood Money Market Funds (DMMF) –Atlas Income Fund (AIF) –Meezan Islamic Fund (MIF) Open Ended Mutual Funds –National Investment Trust (NIT) in public sector –Pakistan Stock Market Fund (PSM) –Pakistan Income Fund (PIF) –Unit Trust of Pakistan (UTP) –UTP Islamic Fund –United Money Market Fund (UMMF) –Dawood Money Market Funds (DMMF) –Atlas Income Fund (AIF) –Meezan Islamic Fund (MIF)

9 Types of Mutual Funds Closed Ended Mutual Funds –It is open for a subscription for a fixed duration as specified in the prospectus of the fund. –The investor can apply for the units of funds only during the initial offered period following which unit can be bought and sold only at the stock exchange where they are listed, at the market price. –Closed mutual funds are really financial securities that are traded on the stock market like stocks or bonds. –Closed end mutual funds are those where the shares are initially offered to the public and are then traded in secondary market –The trading usually occurs at a slight discount to the NAV Closed Ended Mutual Funds –It is open for a subscription for a fixed duration as specified in the prospectus of the fund. –The investor can apply for the units of funds only during the initial offered period following which unit can be bought and sold only at the stock exchange where they are listed, at the market price. –Closed mutual funds are really financial securities that are traded on the stock market like stocks or bonds. –Closed end mutual funds are those where the shares are initially offered to the public and are then traded in secondary market –The trading usually occurs at a slight discount to the NAV

10 Close End mutual funds –Asian Stocks Fund –First Capital Mutual Fund –Golden Arrow Stock Fund –Investec Mutual Fund –Pakistan Premier Fund –Pakistan Capital Mkt Fund –Prudential Stock Fund –Safeway Mutual Fund –Tri-Star Mutual Fund –Asian Stocks Fund –First Capital Mutual Fund –Golden Arrow Stock Fund –Investec Mutual Fund –Pakistan Premier Fund –Pakistan Capital Mkt Fund –Prudential Stock Fund –Safeway Mutual Fund –Tri-Star Mutual Fund

11 Investor Returns from Mutual Fund Ownership NAV - the net asset value of a mutual fund -- equal to the market value of the assets in the mutual fund portfolio divided by number of shares outstanding –NAV reflects the Fund that will be available to the shareholders if the Fund is liquidated and all liabilities are paid Calculation of NAV on an Open-End Mutual Fund Net Asset Value of fund = Sum of Market value of Shares + Liquid Assets /Cash + Dividends/interest – all Liabilities NAV per unit = NAV of funds No. of mutual fund shares outstanding NAV - the net asset value of a mutual fund -- equal to the market value of the assets in the mutual fund portfolio divided by number of shares outstanding –NAV reflects the Fund that will be available to the shareholders if the Fund is liquidated and all liabilities are paid Calculation of NAV on an Open-End Mutual Fund Net Asset Value of fund = Sum of Market value of Shares + Liquid Assets /Cash + Dividends/interest – all Liabilities NAV per unit = NAV of funds No. of mutual fund shares outstanding

12 Types of Mutual Funds Long Term –Equity funds - funds consisting of common and preferred stock securities –Bond funds - funds consisting of fixed-income capital market debt securities, invest in the bonds of government and corporations –Hybrid funds - funds consisting of stock and bond securities Short Term –Money market mutual funds – invest in taxable or tax- exempt money market securities (with maturity of less that one year) invest in government treasury bills and the corporate commercial papers Long Term –Equity funds - funds consisting of common and preferred stock securities –Bond funds - funds consisting of fixed-income capital market debt securities, invest in the bonds of government and corporations –Hybrid funds - funds consisting of stock and bond securities Short Term –Money market mutual funds – invest in taxable or tax- exempt money market securities (with maturity of less that one year) invest in government treasury bills and the corporate commercial papers

13 Other types of investment funds On the basis of objectives –Growth funds Capital appreciation, while the current income may be low Do not pay dividend instead they reinvest The fluctuations in share price may be high Investor with high investment invest Invest in stocks NIT, Meezan Islamic, Pak Stock Market funds –Income funds For periodic payments & small investors invest Fund pays regular income to the investor (dividend) Provide capital stability & little potential for growth Fund includes Corporate Debentures, Govt. Securities, Bonds, etc. UTP Income fund, Atlas Income fund, etc. On the basis of objectives –Growth funds Capital appreciation, while the current income may be low Do not pay dividend instead they reinvest The fluctuations in share price may be high Investor with high investment invest Invest in stocks NIT, Meezan Islamic, Pak Stock Market funds –Income funds For periodic payments & small investors invest Fund pays regular income to the investor (dividend) Provide capital stability & little potential for growth Fund includes Corporate Debentures, Govt. Securities, Bonds, etc. UTP Income fund, Atlas Income fund, etc.

14 Other types of investment funds –Balanced funds Provide both Growth & regular income Invest both in equity & debt in certain proportion The fluctuations in stock price may be low Generally accepted proportion is 55% equity & 45% debt Invest in stocks, corporate debts and Govt. Paper. Unit Trust of Pakistan, Asian Stock Funds, etc. –Tax saving funds Help investor to get tax rebate to the maximum amount of Rs.10,000 Tax concession to increase investment There is a lock-in period of three years, hence it reduce liquidity. –Balanced funds Provide both Growth & regular income Invest both in equity & debt in certain proportion The fluctuations in stock price may be low Generally accepted proportion is 55% equity & 45% debt Invest in stocks, corporate debts and Govt. Paper. Unit Trust of Pakistan, Asian Stock Funds, etc. –Tax saving funds Help investor to get tax rebate to the maximum amount of Rs.10,000 Tax concession to increase investment There is a lock-in period of three years, hence it reduce liquidity.

15 Other types of investment funds On the basis of composition of assets –Equity funds Invest only in the equity market Riskiest as it fluctuates daily due to the volatility in the stock markets Investors looking for capital appreciation invest in it Invested in common shares of corporations Meezan Islamic fund, UTP, NIT, Pak Stock Market Fund, etc. –Debt funds Funds invest in debt market Provide regular income & Low risky Risk averse investors invest in it. On the basis of composition of assets –Equity funds Invest only in the equity market Riskiest as it fluctuates daily due to the volatility in the stock markets Investors looking for capital appreciation invest in it Invested in common shares of corporations Meezan Islamic fund, UTP, NIT, Pak Stock Market Fund, etc. –Debt funds Funds invest in debt market Provide regular income & Low risky Risk averse investors invest in it.

16 –Money Market Mutual Funds Known as liquidity funds Invest in short term instruments T-Bills, Corporate Commercial papers, etc. Regular payments Dawood Money Market funds, Pakistan Income Funds, UTP Income Funds, etc. –Gilt Funds Invest only in Govt. Securities & T-Bills Timely payments No credit risk, but the price risk is always present Short term –Money Market Mutual Funds Known as liquidity funds Invest in short term instruments T-Bills, Corporate Commercial papers, etc. Regular payments Dawood Money Market funds, Pakistan Income Funds, UTP Income Funds, etc. –Gilt Funds Invest only in Govt. Securities & T-Bills Timely payments No credit risk, but the price risk is always present Short term Other types of investment funds

17 Other types of investment funds –Index funds Invest in stocks that are included in the stock index The portfolio of the fund remains almost identical to the proportion of weights of stocks in the index Reputable & profitable stocks have high weights Performance of the index funds exactly follows the performance of stock index. Suppose NBP Index weight 5.96% means shares of NBP are 5.96% of the whole market shares. –Sector funds Invest in the stocks of a particular industry or sector. These funds are riskier as they are not diversified –Index funds Invest in stocks that are included in the stock index The portfolio of the fund remains almost identical to the proportion of weights of stocks in the index Reputable & profitable stocks have high weights Performance of the index funds exactly follows the performance of stock index. Suppose NBP Index weight 5.96% means shares of NBP are 5.96% of the whole market shares. –Sector funds Invest in the stocks of a particular industry or sector. These funds are riskier as they are not diversified

18 Mutual Fund Costs Mutual funds charge shareholders a price or fee Two types of fees are incurred by investors –Load versus No-load Funds Load fund –these funds charges the entry / exit load every time the investor buys/sells the unit of funds. –The charges covers the one time processing fee and transaction cost. –Sell through brokers –Commission is subtracted from the value of shares & paid at the time of purchase No-load fund - a mutual fund that does not charge commission charges on the sale of mutual fund shares to investors –Directly offer to the public with no sales commission Mutual funds charge shareholders a price or fee Two types of fees are incurred by investors –Load versus No-load Funds Load fund –these funds charges the entry / exit load every time the investor buys/sells the unit of funds. –The charges covers the one time processing fee and transaction cost. –Sell through brokers –Commission is subtracted from the value of shares & paid at the time of purchase No-load fund - a mutual fund that does not charge commission charges on the sale of mutual fund shares to investors –Directly offer to the public with no sales commission

19 Advantages of Mutual Funds Low risk Professional management of the investment Low cost of investments Diversification Convenient record keeping and administration Various types of schemes Flexibility Scope of good returns Enables investing in high value stocks Easy liquidity Tax benefits Provide transparency Low risk Professional management of the investment Low cost of investments Diversification Convenient record keeping and administration Various types of schemes Flexibility Scope of good returns Enables investing in high value stocks Easy liquidity Tax benefits Provide transparency

20 Disadvantages of Mutual Funds Economic and Business Conditions Portfolio Managed by Managers Economic and Business Conditions Portfolio Managed by Managers