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Mutual Fund in Pakistan, Types and Performance Evaluation

Mutual Fund in Pakistan, Types and Performance Evaluation

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Published by: bonfument on May 15, 2010
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Mutual Funds in Pakistan
“Mutual fund is a pool of money investedaccording to a common investment objectiveby an asset management company (AMC) onbehalf of the fund’s investors”. A mutual fundcan generate
profits
from three differentsources, which are: Dividend, Capital Gainsand Appreciation of Share Price. The figureshows a mutual fund is deals with the followingentities; trustee, auditor, SECP, AMC andinvestor. A mutual fund provides liquidity,portfolio management expertise, riskdiversification, and stability to stock market
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 and it also mobilises savings by attractingfunds from small investors.
History 
Mutual funds in Pakistan are registered and legally established in the form of a Trust, under the Trust Act of 1882. The mutual fund industry is regulated by, theSecurities and Exchange Commission of Pakistan (SECP) which licenses each AssetManagement Company in strict compliance with the NBFC Rules, 2003 and requiresall AMC’s to obtain an independent rating
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.Mutual Funds were introduced in Pakistan in 1962, with the public offering of National Investment (Unit) Trust (NIT), followed by the establishment of theInvestment Corporation of Pakistan (ICP) in 1966.
Rate of Return
“A return is a measurement of how much an investment has increased or decreasedin value over any given time period”. The return of a mutual fund is calculated byusing the following formula;
(Final NAV + Distributions - Original NAV) / (Original NAV) X 100
Returns basically show how your investment has increased or decreased in value.Compounding earns returns on your returns and Transaction costs reduce returns.
Rules Govern Mutual Funds in Pakistan
1 http://www.pakistaneconomist.com/database2/cover/c96-72.asp2 www.igifunds.com.pk/knowledgeCenter.asp
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 There are two rules govern mutual funds in Pakistan, which are:1.Investment Companies and Investment Advisors' Rules, 1971. (Govern closed-end mutual funds)2.Asset Management Companies Rules, 1995. (Govern open-ended mutual funds)
Types of Mutual Funds
Mutual funds can be characterized as ‘Open’ or ‘Closed’ End
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.
1.Open-End Funds
Open-End funds continually issue new units and redeem outstanding units uponinvestor request. The unit holders buy units of the fund or may redeem them at thepublished Net Asset Value (NAV). Typically, these funds have a perpetual lifespan. The asset management company launches the fund and continues to
 
remain thecounter party in the sale and purchase transactions with the unit holder.In Pakistan there exists 34 open ended mutual funds (as of 2006) including NationalInvestment (Unit) Trust (NIT) in the public sector and Atlas Income Fund, CrosbyDragon Fund and Faysal Balanced Growth Fund.
2.Closed-End Funds:
In Closed-End funds, a fixed number of share certificates are issued by the fund; theshares trade in the secondary markets (stock markets). Market price of the sharecertificates is determined by their demand and supply and they do not necessarilytrade at NAV. Though many of these funds have a perpetual lifespan, others have afinite lifespan. The asset management company launches the fund and no longerremains the counter party in the sales and purchase transactions with the unitholder.In Pakistan there exist 22 close ended mutual funds (as of 2006) including Al-Meezan Mutual Fund, Asian Stocks Fund and ABAMCO Composite Fund. To summarize both types of funds, a concise description of them are listed below
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.
Open-end fundClose-end fund
Issues redeemable units
Issues irredeemable shares
3 http://www.kse.com.pk/text/mutualFund.pdf 4 http://www.accountancy.com.pk/articles_students.asp?id=148
2 |Page
 
Not necessarily listed
Does not conduct generalmeetings of unit holders
No voting rights of unit holders
May issue as many units andredeem them at NAV
Each time, units are directlyacquired from or sold to thecompany through their authorizedoffices
License of investment advisory isrequired
Units are traded at NAV
Listed
Conducts AGMs
Bestow voting rights toshareholders
Has fixed pool of money anddoes not continuously offershares, however may increaseits capital under the CompaniesOrdinance
Shares are acquired from thecompany on initial public offerand from existing shareholdersafterwards
License of asset managementservices is required
Shares are trades at marketprice rather NAV reported by thefund manager
Performance evaluation of Mutual Funds
We have two major requirements of a portfolio management. One is the ability toderive above average returns for a given risk class (large risk-adjusted returns); andsecond is the ability to completely diversify the portfolio to eliminate allunsystematic risk. Mainly on these two basis a proformane of mutual fund ismeasured. The folowing are some of the ways used to measure the efficiency andperformance of mutual funds.
 Jensen Alpha
 Jensen alpha is used to measure the excess returns on a portfolio, which helps in itspricing. It is developed byMichael Jensenin the 1970's
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. To calculate alpha themarket return, therisk-free rateof return, and thebetaof the portfolio is used as inputs. The following formula is used to calculate Jensen alpha.
 Jensen's alpha = Portfolio Return - (Risk Free Rate + Portfolio Beta(Market Return - Risk Free Rate))
Sharpe Ratio
5 http://en.wikipedia.org/wiki/Jensen%27s_alpha
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