Mutual Funds

Report
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MUTUAL FUNDS
BY
MUHAMMAD RASHID ZAFER, ACA
WHAT IS MUTUAL FUND
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An investment vehicle that pools money from many
investors and invest it according to predetermined
objective.
Each investor gets a share of the pool
proportionate to the initial investment.
Capital of the mutual fund is divided into shares or
units.
Mutual funds invest in bonds, stocks, money-market
instruments, real estate, commodities or a
combination of any of these.
FLOW OF FUNDS
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HISTORY OF MUTUAL FUNDS
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The first mutual fund was established in Europe.
A Dutch merchant Adriaan van Ketwich created the
first mutual fund in 1774. “Eendragt Maakt Magt”,
which meant “Unity Creates Strength”.
First mutual fund outside the Netherlands was the
Foreign & Colonial Government Trust, which was
established in London in 1868.
Mutual funds were introduced into the United States
in the 1890s. They became popular during the
1920s.
HISTORY OF MUTUAL FUNDS
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In 1893, the first closed-end fund “The Boston
Personal Property Trust” was formed.
In year 1924, the first open-end fund
“Massachusetts Investors’ Trust of Boston” was the
formed.
In Pakistan NIT offered first open end fund in 1962.
ICP offered a series of closed end funds in 1966,
these were later privatized in 2000.
PROS AND CONS OF MUTUAL
FUNDS
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Diversification. Securities from hundreds or even
thousands of issuers it reduces the risk of loss.
Professional Management. Expertise to manage and
reinvest interest or dividend income, or to investigate
thousands of securities. Access to extensive research,
market information, and skilled securities traders.
Liquidity. Mutual fund can be bought and sold on any
business day, so investors have easy access to their
money. Many individual securities can also be bought
and sold readily, others aren't widely traded. (CE & IC)
PROS AND CONS OF MUTUAL
FUNDS
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Convenience. Mutual funds offer services that make
investing easier. Mail, telephone, or the Internet.
Automatic investments into a fund or automatic
transfers from a fund to your bank account.
Tax Free Return The stock dividend from mutual
funds are exempt from tax. Cash dividend taxable.
PROS AND CONS OF MUTUAL
FUNDS
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No Guarantees. Unlike bank deposits, principal and
returns are not guaranteed.
Diversification “Penalty." Diversification reduces
the risk of loss, it also limits the potential for making
a killing in the market. Diversification does not
protect from a loss caused by an overall decline in
financial markets.
MUTUAL FUNDS - STRUCTURES
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Open End – continuously offer and redeem their
units to the investors.
Closed End – one time issuance of certificates and
then are traded in the secondary market.
Investment Company – one time issuance of shares
and then are traded in the secondary market.
LEGAL STRUCTURE
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Open end and closed end funds are established
through a trust deed as a trust under the trust act 1888.
Investment Company is established as a limited liability
company.
Operated by two parties i.e. fund manager and the
trustee or custodian.
CDC - largest trustee of mutual funds in Pakistan with
almost 90% of the market share.
SECP through NBFC Regulations 2008 regulates the
mutual fund industry.
TERMINOLOGIES & DOCUMENTS
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Net Asset Value
Trust Deed
Offering Documents
Sales Load
PARTIES TO MUTUAL FUND
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Fund Manager
 Manage the assets of the mutual fund.
 Maintenance of financial and other records and
documents.
 Maintenance of the record of unit or certificate
holders.
 Receipt and processing of investment and
redemption applications.
PARTIES TO MUTUAL FUND
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Trustee
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Hold all the property mutual fund for the unit or
certificate holder.
Settlement of transaction entered into by the fund
manager.
Ensure the methodology and procedures adopted by the
fund manager in calculating the value of units are
adequate.
Monitoring of the actions of fund manager in the light of
applicable law i.e. to act as front line regulator.
MUTUAL FUNDS - TYPES
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Money Market Fund – invest mainly in money market
instruments i.e. fixed income securities with short
maturity and high credit quality.
Bond Fund – invest mainly in bonds having longer
maturity.
Equity Funds – invest primarily in stocks.
Hybrid Funds – invest in both bonds and stocks.
Index Fund or Index Tracker – aims to replicate the
movements of an index regardless of market
conditions.
MUTUAL FUNDS – TYPES - PAKISTAN
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Equity Fund
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At least 70% of the net assets invested in listed equity
securities.
Remaining net assets invested in cash or near cash
instruments, treasury bills.
No exposure in CFS.
MUTUAL FUNDS – TYPES - PAKISTAN
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Balanced Fund
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30% to 70 % invested in listed equity securities.
Remaining assets in money market instruments, commercial
paper, reverse repo, TFCs, sukuks, CFS, spread, preference
shares.
Rating of debt security not lower than A-.
Rating of bank not lower than AA-.
Weighted average time to maturity of non equity assets
should not exceed 2 years.
Investment in CFS and spread should not exceed 25%.
MUTUAL FUNDS – TYPES - PAKISTAN
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Asset Allocation Fund
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May invest in any type of security at any time and may
diversify as per the offering document.
The offering document must specify the types of
securities and the rating criteria.
MUTUAL FUNDS – TYPES - PAKISTAN
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Fund of Funds
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Invest its assets in other funds only.
Remaining in bank accounts and treasury bills not
exceeding 90 days.
Must not invest in seed capital.
May be equity, income, money market etc.
MUTUAL FUNDS – TYPES - PAKISTAN
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Capital Protected / Guaranteed Fund
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Make investments in such manner that the original
capital is protected while yielding positive returns.
Normally capital protection is achieved by placing the
capital in term deposits with bank.
Rating of the bank should not be lower than AA-.
MUTUAL FUNDS – TYPES - PAKISTAN
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Index Fund
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Strive to remain fully invested in accordance with the
stated index.
Under no circumstances investment fall below 85% of
the assets in securities covered in the index.
Any remaining asset must be kept in bank account or
treasury bills not exceeding 90 days.
Efficient Market Hypothesis
MUTUAL FUNDS – TYPES - PAKISTAN
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Money Market Fund
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Invest in cash and near cash instruments i.e. treasury
bills, money market instruments, commercial papers,
reverse repo etc.
No exposure in equities, CFS, spread transaction.
Rating of any security should not be lower than AA.
Maturity time of any asset should not exceed six
months.
Weighted average time to maturity should not exceed
90 days.
MUTUAL FUNDS – TYPES - PAKISTAN
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Income Fund
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Invest in government securities, TDRs, commercial
papers, reverse repo, TFCs/sukuks, CFS, spread
transactions.
Rating of any security should not be lower than
investment grade.
No restriction regarding time to maturity of any single
assets in the portfolio.
Weighted average time to maturity of assets shall not
exceed 4 years.
MUTUAL FUNDS – TYPES - PAKISTAN
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Aggressive Fixed Income Fund
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Invest in government securities, TDRs, cmmercial papers,
reverse repo, TFCs/sukuks, CFS, spread transaction.
Both rated and unrated security are eligible for
investment.
No restriction regarding time to maturity of any single
assets in the portfolio.
Weighted average time to maturity of assets shall not
exceed 5 years.
MUTUAL FUNDS – TYPES - PAKISTAN
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Islamic Funds
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May be categorized as income, money market, fund of
funds, equity, balanced or index tracker.
All the investments must be Shariah compliant.
Investment avenues includes Shariah compliant stocks,
sukuks, deposit with Islamic banks, spread transactions
etc.
SCREENING CRITERAIA FOR ISLAMIC
EQUITY FUNDS
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Criteria – 1 Business of the Investee Company
The business of the investee company should be Halal.
Criteria – 2 Illiquid Assets Must be 20% of the Total
Assets
Illiquid assets means plant and machinery, inventory
etc.
Criteria – 3 Market Price Per Share > Net Liquid
Assets Per Share
Net Liquid Assets = TA-ILA-TL
SCREENING CRITERAIA FOR ISLAMIC
FUNDS
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Criteria – 4 Non-Compliant Income < 5% of Gross
Revenue
Non Compliant Income includes interest, income from
gambling, gains on derivatives.
Criteria – 5 Non-Shariah Compliant Investments <
33% of Total Assets
Non-Shariah Compliant Investments include
investments in money market funds, money market
instruments, bonds, PIBs, CoIs, CoDs, TFCs, DSCs,
derivatives etc.
SCREENING CRITERAIA FOR ISLAMIC
FUNDS
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Criteria – 6 Interest Bearing Debt < 40% of Total
Assets
Interest bearing debt includes bonds, TFCs,
conventional bank loans, finance lease, and
preference shares etc.
DEBT VERSUS EQUITY FINANCING
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Debt financing is a double edged sword.
Leveraged companies can magnify their returns in
booms, but in slumps, they lose the edge and can even
go bankrupt.
Debt financing results in a zero-sum game in which at
least one stakeholder i.e. shareholders or creditors
suffer.
Equity financing ensures normal returns in booms and
survival in slumps. Therefore, the company will not be
squeezed of liquidity as interest expense as an
‘autonomous expense’ will not feature as a significant
portion of total operating expenses.
A SIMPLIFIED ECONOMIC MODEL
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Non Leverage Company
Assets
Rs.
Equity + Liability
Rs.
Fixed Assets
60
Debt
0
Current Assets
40
Equity
100
100
Total
100
Total
A SIMPLIFIED ECONOMIC MODEL
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Economic Boom
Income Statement
Non Leveraged Company
Net Sales
Economic Recession
Income Statement
Rs.
Non Leveraged Company
100 Net Sales
Rs.
60
Cost of Goods Sold
70 Cost of Goods Sold (70%)
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Gross Profit
30 Gross Profit
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Operating Expenses
10 Operating Expenses
10
PBIT
20 PBIT
Interest Expense
PBT
Tax Expense (20%)
Net Income
ROE
0 Interest Expense
20 PBT
4 Tax Expense
16 Net Income
16% ROE
8
0
8
1.6
6.4
6.4%
A SIMPLIFIED ECONOMIC MODEL
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Leveraged Company
Assets
Rs.
Equity + Liability
Rs.
Fixed Assets
60 Debt
60
Current Assets
40 Equity
40
Total
100 Total
100
A SIMPLIFIED ECONOMIC MODEL
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Economic Boom
Income Statement
Leveraged Company
Net Sales
Economic Recession
Income Statement
Rs.
Leveraged Company
100 Net Sales
Rs.
60
Cost of Goods Sold
70 Cost of Goods Sold
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Gross Profit
30 Gross Profit
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Operating Expenses
10 Operating Expenses
10
PBIT
20 PBIT
Interest Expense (12%)
7.2 Interest Expense
PBT
12.8 PBT
Tax Expense (20%)
2.56 Tax Expense
Net Income
ROE
10.24 Net Income
25.6% ROE
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7.2
0.8
0.16
0.64
1.6%
TAX STRUCTURE
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Income Tax Ordinance, 2001
Income of mutual fund is exempt subject to distribution of
ninety percent of accounting income reduced by capital
gains realized or unrealized.
Mutual funds are also exempt from withholding tax and
capital gains tax.
Investor will be taxed on cash dividend @ 10% stock
dividend exempt.
Investors have to pay capital gains tax if units, certificates
or shares are redeemed/sold before one year.
Investors also get rebate on income tax on their investment in
mutual funds.
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THANK YOU!
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