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An Introduction to Mutual Funds

Presented by
Umair Javed Imam

AVAIS HYDER LIAQUAT NOUMAN


CHARTERED ACCOUNTANTS
What Is a Mutual Fund?

A mutual fund is a company that invests in a diversified


portfolio of securities. People who buy shares of
a mutual fund are its owners or shareholders. Their
investments provide the money for a mutual fund to
buy securities such as stocks and bonds. A mutual fund
can make money from its securities in two ways: a
security can pay dividends or interest to the fund, or a
security can rise in value. A fund can also lose money
and drop in value.

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New to Mutual Funds
• Pooled vehicle
• Professional Management
• Investment Plans
• Legal Framework
• Investors
• Trustees
• Asset Management Company
• Registrar
• Custodian

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POOLED VEHICLE
• A Mutual Fund is a vehicle to pool money
from investors, with a promise that the money
would be invested in a particular manner, by
professional managers who are expected to
honor the promise.
• In Pakistan the Mutual Funds are governed by
the regulations of Securities and Exchange
Commission of Pakistan (SECP).

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PROFESSIONAL MANAGEMENT

• The idea behind a mutual Fund is that individual


investors generally lack the time, the inclination or
the skills to manage their own investments. Thus,
mutual funds hire professional managers to manage
the investments for the benefit of their investors in
return for a management fee.
• The organization that manages the investment is the
Asset Management Company (AMC). Employees of
the AMC who perform this role of the managing
investments are the fund managers 5
INVESTMENT PLANS
(SCHEMES)
• Investors have their individual preferences on how they would
like their money invested and how much risk they are willing
to take.
• An individual investor could choose to hire a professional
manager to manage his/her money as per his/her investment
and risk preferences. Such personal treatment, often referred to
as Portfolio Management Schemes (PMS).
• It is possible to balance the time and cost required to manage
investments by grouping investors together based on their
preferences. In this manner, the focus of the investment
activity can be shifted from a single investor (in case of PMS)
to a group of investors having similar expectations (in case of
mutual fund).

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LEGAL FRAMEWORK
• Across the world, the mutual fund sector is viewed as a critical
mechanism to channel investor funds into the capital market.
Since these investors are often not so well qualified to invest,
the mutual fund business is highly regulated.
• Regulations vary from country to country. But broadly, they
provide for:
• Checks and balances in the legal structure;
• Pre-qualifications to start a mutual fund;
• Permissible schemes and investments;
• Control over marketing process;
• Level of operational flexibility to the professional investors;
and
• Valuation of securities, etc.
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INVESTMENT GURU
Warren Edward Buffet (born August
30, 1930, in Omaha, Nebraska) is an
American investor, businessman and
philanthropist. He is regarded as one of
the world's greatest stock market
investors, and is the largest shareholder
and CEO of Berkshire Hathaway. With
an estimated net worth of around US$62
billion, he was ranked by Forbes as the
richest person in the world as of
February 11, 2008.

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Who are the Parties Involved?
Investors
• Mutual Fund is a solution for investors who
lack the time, the inclination or the skills to
actively manage their investment risk in
individual securities. They can delegate this
role to the mutual fund, while retaining the
right and the obligation to monitor their
investments in the scheme

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Trustees
• Trustees are the people within a mutual fund
organization who are responsible for ensuring
that investors interests in a scheme are
properly taken care of.
• In return for their services, they are paid
trustee fees, which are normally charged to the
scheme.

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Asset Management Company (AMC)
• AMCs manage the investment portfolios of funds. An
AMC's income comes from the management fees it
charges the fund it manages.
• In order to earn the management fee, an AMC has
naturally to employ people and bear all the
establishment costs that are related to its activity,
such as for premises, furniture, computers and other
assets, software development communication costs,
etc. These are to be met out of the management fee
earned. Expenses such as on trustee fees, marketing,
etc. can be directly borne by the mutual fund.
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Registrar
• An investor's holding in mutual fund schemes is
typically tracked by the scheme's registrar and
transfer agent (R&T). Some AMCs prefer to handle
this role in-house, i.e. on their own instead of
appointing an R&T. The registrar or the AMC as the
case may be maintains an account of the investor's
investments in and disinvestment from the schemes.
Requests to invest more money into a scheme, or to
redeem money against existing investments in a
scheme are processed by the R&T.
mutual fund scheme.
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Custodian / Depository
• The custodian maintains custody of the
securities in which the schemes invests-as
distinct from the registrar who tracks the
investment by investors in the scheme.
This ensures an ongoing independent record of
the investments of the scheme.

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INVESTMENT GURU
• George Soros (born August 12, 1930,
in Budapest, Hungary, is a Hungarian-
born American financial speculator,
stock investor, philanthropist, and
political activist
• Soros is famously known for "breaking
the Bank of England on Black
Wednesday in 1992. With an estimated
current net worth of around $8.5
billion, he is ranked by Forbes as the
80th-richest person in the world.

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Types Of Mutual Funds
• Open End Fund
• Close End Fund

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Open-end Fund
• These are mutual funds which continually
create new units or redeem issued units on
demand. They are also called unit trusts,
because they are registered as trusts. The unit
holders buy the units of the fund or may
redeem them on a continuous basis at the
prevailing NAV.

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Closed-end Fund
• Closed-end funds can be floated under a
company structure as well as a trust structure.
In case of trust structure, a fixed number of
certificates are issued (shares in the case of a
company structure) during an initial public
offering (IPO). These certificates/shares are
listed on a stock exchange for secondary
trading .

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Net Asset Value
• A fund's NAV is equal to the market value of
its underlying assets, which include stocks,
bonds and other securities and assets which are
held in the portfolio, minus liabilities, divided
by the number of units or shares outstanding.

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ASSET VALUE

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INVESTMENT GURU
• Dr. Joseph Mark Mobius (born
August 17, 1936) is a global investor
and emerging markets fund manager,
and is considered to be one of the
leaders in the industry as he has been
involved in these markets for over 40
years
• Dr J Mark Mobius, to give him his
official title, is a fund manager. He
works for Templeton Worldwide, the
American mutual fund business and
right now has about $10-billion of
other people's money to look after.
In fact, some of it is his own; he will
not say how much it is, probably a
few million dollars

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Mutual Fund Categories
• Equity Funds • Islamic fund
• Income Funds • Index Funds
• Balanced Funds • Sector Funds

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Equity Funds
• Equity Funds invest primarily in the stocks of
various types of companies. The types of
stocks in which an equity fund will invest will
depend upon the fund's investment objectives,
policies, and strategies.

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Income Funds
• Income Funds: Income funds aim towards
providing a regular stream of income to the
investor. To accomplish this goal they invest
in medium to long term instruments such as
Term Finance Certificates (TFC), government
securities, and a combination of short term
CFS (Continuous Funding System) and high
yielding deposits.

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Balanced Funds
• The strategy of balanced funds is to combine
securities from different asset classes in
varying proportions to help manage moderate
risk and consistent return. These funds
generally tend to invest up to 65% in equity
securities and the remaining in fixed income
instruments.

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Islamic Funds
• In case of Islamic Funds, the investment made
in different instruments is to be in line with the
Islamic Shairah Rules. The Fund is generally
to be governed by an Islamic Shariah Board.
And then there is a purification process that
needs to be followed, as some of the money
lying in reserve may gain interest, which is not
desirable in case of Islamic investments.

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Index Funds
• The intent of an index fund is basically to
track the performance of the stock market. If
the overall market advances, a good index
fund follows the rise. When the market
declines, so will the index fund. Index funds'
portfolios consist of securities listed on the
popular stock market indices.

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Sector Funds
• As was noted earlier, most mutual funds have
fairly broad-based, diversified portfolios. In
the case of sector funds, however, the
portfolios consist of investment from only one
sector of the economy. Sector funds
concentrate in one specific market segment;
for example, energy, transportation, precious
metals, health sciences, utilities, leisure
industries, etc. In other words, they are very
narrowly based.
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How Mutual Funds Generate
Their Income
Depending on the investment policy of the mutual funds, the
main sources of income are
• Dividends from equity investments.
• Return from term finance certificate or corporate paper.
• Profit from Government securities.
• Return on deposits/ COIs with banks/ financial institutions.
• Profit from money market transactions.
• Profit from PLS accounts with banks.
• Capital gains or losses on sale of equity securities, term finance
certificates and Government securities.
• Any appreciation in the value of investment, but not realized, is not
taken as income, but recognized for calculating the NAV.

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Mutual Funds in Pakistan
Major Players
Asset Management Companies How Mutual Funds have evolved in
• JS Pakistan?
• UBL
• PICIC Investment Corporation of Pakistan
• Almeezan and National Investment Trust were
pioneers in establishing close-end
• AKD and open-end mutual funds.
• Arif Habib
• Atlas Presently open-ended mutual funds
• NAMCO stand at Rs. 325 b [Feb-2008]. The
• HBL market cap of close end mutual
• BMA funds was Rs. 36.24 b [11-4-08].
• Askari
• IGI Out of Rs. 325 b open end funds, Rs.
• AMZ 124 b [38%] were in equity funds,
and Rs. 127 b [39%] were in
• Dawood income fund.
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What are the potential advantages of
investing in
mutual funds?

There are many reasons why people invest in mutual funds:

Diversification: Investing in a number of different


securities helps reduce the risk of investing. When
you buy a mutual fund, you are buying an interest in
a portfolio of dozens of different securities, giving you
instant diversification, at least within the type
of securities held in the fund.

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There are many reasons why people
invest in mutual funds:

Professional Management: Mutual funds are managed


by professionals who are experienced in investing
money and who have the skills and resources to
research many different investment opportunities.

Performance Monitoring: The value of most mutual


funds is reported daily in the financial press and
on many internet sites, allowing you to continually
monitor the performance of your investment.

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There are many reasons why people
invest in mutual funds:
• Liquidity: Units or shares of mutual funds can be
redeemed at any time in open end fund.

• Flexibility: Many mutual fund companies administer


several different mutual funds (e.g., money market,
fixed-income, growth, balanced and international
funds) and allow you to switch between funds within
their ‘fund family’ at little or no charge. This can enable
you to change the balance of your portfolio as your
personal needs or market conditions change.

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What are some of the potential
disadvantages?
When you invest in a mutual fund you place your money
in the hands of a professional manager. The return on
your investment will depend heavily on that manager’s skill
and judgement. Even the best portfolio advisers are wrong
sometimes, and studies have shown that few portfolio
advisers are able to consistently out-perform the market.
Check the fund manager’s track record over a period of
time when choosing a fund.

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What are some of the potential
disadvantages?

As a mutual fund investor, you will also be paying, through


management expenses and commissions, for management
services and for various administrative and sales costs.
Those fees and commissions reduce the return on your
investment and are charged, in almost all cases, whether
the fund performs well or not. Sales commissions and
redemption fees can have a very significant impact on your
return if you decide to redeem your mutual fund investment
in the short-term.
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FRONT END LOAD/BACK END
LOAD
Sales Charges (Loads) are the commissions that you may
have to pay when you buy or redeem units of a fund. Sales
charges may be applied when you buy units of the fund
(a front-end load), when you redeem your units (a back-end
load), or there may be no sales charges at all (no-load).
Where front-end loads are charged, the rate can vary from
dealer to dealer and may be negotiable.

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RISK INVOLVED
The funds management apart from following the rules laid
down by the SECP has also internally spelled out elaborate
risk management procedures to manage the risk based on the
guidelines divided among the following three major
components:

Identifying Investment Risk

Risk Measurement

Risk Management

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Identifying Investment Risk

• In order to properly and efficiently manage risks, the


first step taken by Mutual Funds Risk Management
team is identifying the risks associated with
Investments. There are a number of risk types that the
Mutual Funds recognize in making investments.
These are; Market Risk of volatile market values,
Credit Risk of changing credit qualities, Spread Risks
relate to uncertain cost of credit, Liquidity Risk and
Operational risk that are of potential loss due to
process failure.
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Risk Measurement
Once the risks are identified, measuring the risk level is
another stage of risk management. The risk measurement
methods used by Mutual Funds are:

• Positions: all investments must be recorded and reported


• Valuations: independent valuations by mark-to-market or mark-to-model
for unlisted holdings
• Sensitivities: detailed sensitivity of value to changes in market factors –
interest rates, credit spreads, prices, volatilities, currencies
• Stress Tests: potential impact of extreme market moves
• Back-testing: comparing realized returns with expected returns to
validate the process
• Attribution: attribution of risks to the investment process such as
strategy/tactics/execution, market/style/selection,
currency/price/interest/spread

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Risk Management
• The final step of managing risk involves
comparing the risk measured to the risk profile
of the respective investments. Risk
management is asking all of the questions and
believing none of the answers and it is an on-
going process that takes time.
• These functions are executed using analytical
tools such as Bloomberg and Mat Lab.

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SAMPLE CASE STUDY
OF
XYZ COMPANY

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ORGANIZATIONAL
PLAN
OF
XYZ COMPANY

Treasury Department
Settlement Department
Accounts Department
Marketing Department
Human Resource Department
Information Technology Department
Research and Development
Administration Department
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• Treasury Department • Settlement Department

• The treasury department is • The settlement department


responsible for the optimal is responsible to clearing all
allocation of the funds held by the
xyz ltd. It works in close transactions with all parties.
coordination with the accounting In verifies the entries made
and settlement departments in in the system for its trades
order to manage the cash flows, made by the treasury and in
documentation and clearing of responsible for the related
transactions with external parties
such as brokers, trustees and paperwork and
counter parties. communication with outside
• The primary function of the parties as well as with the
department is to carry out the trustees regarding deliveries
allocation of assets in funds. and payments.
• The settlement head
maintains information on
redemptions, investments,
placements and settlement
of transactions.
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• Accounts Department • Marketing Department

• The accounts department is • Marketing is one of the most


responsible for recording the important instruments of
funds’ related transactions that business plan. Without
marketing, people will not be
take place as well as able to find what business is
maintaining the accounting about and all services.
records on a daily basis. It also Marketing is most important
handles the cash placements in activity in a business because it
various banks in order to has a direct effect on
handle it in efficient manner.
profitability and sales. There are
different methods when it
The decision regarding the comes to marketing. This
cash placements is backed by includes direct marketing,
the investment committee. relationship marketing,
advertising, public relations,
and positioning.
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Research and Development
• Risk department provides research-based information
to the high net worth individual and institutional
clients with pertinent facts to assist them in buying or
selling securities. Research department of the
company is meticulously judging the effects of subtle
market as well as analysis past and present company
and industry record. Research Department also
evaluates marketing as well as operational strategies
of the companies in order to give authentic
information to the clients. Resources which personnel
of research department use include reference manuals,
statistical reports, corporate financial statements, and
business and government publications.
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STANDARD OPERATING
PROCEDURES (SOP)
OF
XYZ COMPANY

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SOP OF XYZ COMPANY
• INTRODUCTION, PURPOSE AND SCOPE

OBJECTIVE
• The principal objective of the Manual is to provide personnel
with a standard document to serve as a guideline in carrying
out their responsibilities. Compliance with the Manual is
mandatory to ensure a sound accounting and internal control
environment and to facilitate generation of necessary
information in an effective and efficient manner. Accordingly,
the policies and procedures detailed in this Manual must be
complied with by all the concerned employees of the
company.

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SOP OF XYZ COMPANY
• SCOPE
• The Manual applies to all personnel involved in the
operations of the company. It will play a key role in
communicating and maintaining the company’s
operating and financial policies and procedures and
internal control system.
• Further, powers and responsibilities exercisable by
employees of the company shall be governed by the
‘signature mandate’ of the company as issued and
amended from time to time.

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SOP OF XYZ COMPANY
RECEIPTS AND PAYMENTS

No Dealing in Cash Except for Certain Transactions


• The Company will not deal in cash for either payments or receipts, except for petty
cash transactions.

Receipts
• Receipts of the management company include, but are not limited to, the following:

» Management Fee
» Front end / Back end load
» Dividend and Mark-up / Profit
» Disposal of Investments & Trading Gains
» Carry Over Transactions
» Profit / Mark-up on Bank Account and Debt Instruments
» Disposal of Fixed Assets
» Arrangement Fee, Participation Fee, etc.
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SOP OF XYZ COMPANY
TRANSACTIONS WITH BROKERS
Objective
I. All transactions of equity and money market of XYZ and
Mutual Funds shall only be made through authorized
brokers.
II. Responsibility
Brokerage shall be paid to brokers at agreed rates. In
case, brokerage is to be paid at a rate other than agreed
rate, the same has to be approved by at least two of
CIO, CEO, and one Director.

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SOP OF XYZ COMPANY
• BANK RECONCILIATION
• Time Line
• I. Any cheque deposited that has not been cleared for more
than two working days shall be reported to the CFO
immediately.
• II. Any stale cheque (cheque that has not been presented
within 6 months of the date of issue) shall be reversed with the
reinstatement of related liability.

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SOP OF XYZ COMPANY
RISK MANAGEMENT

Introduction
• I. The Fund Management division manages mutual funds that
may be investing in equities, fixed income and derivatives. As well
as managing the risk of stock market and interest rate movements,
the department is involved in monitoring the credit risk of bond
issuers, depositary institutions, and brokers.
• General
• The Fund Management staff must be well versed with relevant
Laws and Regulations
• II. The Fund Management staff must comply with all the
procedures as laid down in Sections of the SOPs.

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SOP OF XYZ COMPANY
• MIS AND FINANCIAL REPORTING
• Objective
• I. To declare NAV for investment and redemption requests,
sending to newspapers, stock exchange(s) and SECP, and
Board of Directors.
• II. As per Rule 80(4) of the NBFC Rules and with compliance
of the Offering Document of the respective fund there must be
at least four regular dealing days per week.
• The said report shall be prepared by Associate Operations,
reviewed and approved by CFO and CEO.
• III. After the NAV bunch has been reviewed and approved by
CFO, CFO shall authorize NAV to be sent to newspapers,
stock exchange(s) and SECP through fax or e-mail.

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SOP OF XYZ COMPANY
Net Assets Value (NAV)

• Procedure for calculation of NAV


• NAV means the excess of assets over liabilities.
• NAV shall be calculated in accordance with the
principles mentioned in clause (xxxiv) of Rule 2
of the NBFC Rules, 2003 except for the valuation
of debt instruments that shall be valued on the
basis of discounted cash flow method as allowed
under the International Accounting Standards and
approved by the Board of Directors through
resolution dated April 27, 2005.
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SOP OF XYZ COMPANY
• Borrowings
• Objective
• To set out the procedures for undertaking borrowings on behalf of
the Fund.
• Responsibility
• Borrowings shall be made with the prior approval of the Board of
Directors.
• Purpose for which borrowings can be made
• The Management Company may cause the Fund (Trustee) to
borrow amounts not exceeding fifteen percent of the total Net
Asset Value of the Fund (or such limits prescribed by the Rules).
• Borrowing shall be carried out only to meet redemption requests
and shall be repayable within a period of ninety days.

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An Introduction to Mutual
Funds

THE END
Thank you for being with us

AVAIS HYDER LIAQUAT NOUMAN


CHARTERED ACCOUNTANTS
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