PERFORMANCE OF PAKISTANI CLOSED ENDED MUTUAL FUNDS

Abstract

This paper provides an overview of the Pakistani mutual fund industry and investigates the

mutual funds risk adjusted performance using mutual fund performance evaluation models. The

performance of these funds cannot be considered to be very good relative to the market portfolio.

These results are however, not different from results of studies conducted over much longer

periods in US and Europe. There also a small proportion of funds (approximately 30 percent)

beat the market in a given period, but the compositions of these market beaters kept on changing

from period to period, thus suggesting no special competency on the part of the mutual funds to

consistently beat the market.

Key word: Closed ended mutual funds, Sharpe’s model, Treynor’s model
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Performance of closed ended mutual funds of Pakistan

When money is invested in a mutual fund it means one has hired a professional to take care

of one’s investment. A mutual fund is just like an investment plate form that can be resembled

with a basket filled with many stocks, bonds and other financial assets. An investor by putting

money in a mutual fund purchases a portion of all those financial assets which are at that basket.

In simple words mutual fund pools money from the investors and that pooled money is invested

in different sort of financial assets to form a well diversified portfolio. Mutual funds industry has

been exploded in the world because of two main reasons, firstly an efficient vehicle for

individual investor to participate in market and secondly investment in a mutual fund tends to be

less risky because of diversification.

Different mutual funds have different investment objectives. Some funds are growth

oriented and some are returns oriented but in general mutual funds help investors in reducing

their risk in stocks as they are diversified among many shares and stocks and managed by a team

of professionals. In essence mutual funds are institution established for the purpose of benefiting

small investors who cannot invest directly in various securities.

In financial market first fund was started in 1924 [ CITATION Fis06 \l 1033 ] and this

concept of mutual funds in Pakistan emerged in 70’s when National Investment Trust was

established as an open ended mutual fund and is the largest and first mutual fund of Pakistan. It

came into existence at 12th November 1962 under a trust deed. It was followed by Investment

Corporation of Pakistan established in February 1966. It was a close-end mutual fund and

objective of its establishment was to enhance the base and development of capital markets of

Pakistan. ICP floated 26 funds up to early 1990’s but it was privatized in 2002 and its 12 funds
PERFORMANCE OF PAKISTANI CLOSED ENDED MUTUAL FUNDS
4

were acquired by ABAMCO Limited. Mutual funds usually are of two types i.e. open end and

close end mutual funds. Close end mutual funds work like companies. Their shares are firstly

offered in primary market and then are traded in secondary market. Whenever these funds want

to enhance equity they offer shares to general public and raise capital like public limited

companies. Currently in Pakistan there are twenty-two close ended mutual funds. The rules

which govern the working of close ended mutual funds are laid down in Investment Companies

and Investment Advisors' Rules, 1971. Another famous type of mutual funds is open end mutual

fund. This mutual fund is characterized by the continual selling and redeeming its shares that

means these mutual funds do not offer fixed capitalization (Fischer & Jordan, 2006). The

ownership of an open end mutual funds is not limited to particular members and remains open

for new investors. In Pakistan there are forty-three open end mutual funds and working of these

mutual funds is governed according to the provisions of Asset Management Companies Rules,

1995.

Evaluating the performance of mutual funds is pretty simple if we consider only returns

of the mutual funds but it is wrong also. For proper evaluation the element of risk must be

considered. At one time the investors evaluated mutual funds performance on the basis of rate of

return. They were aware of risk but did not know how to quantify or measure it. Development in

portfolio theory in early 1960s enabled investors to quantify Risk of a portfolio as it must be

considered while evaluating its performance. By risk we mean, deviations from expectations but

these is no universally accepted definition of risk. According to (Sipra, 2006) in finance, risk can

be defined in two ways one is standard deviation and other is beta. These two have been

employed in this paper to measure the performance of mutual funds.

PERFORMANCE OF PAKISTANI CLOSED ENDED MUTUAL FUNDS
5

Although Pakistani mutual funds flourished during the period of 1999-2005 with net asset

value which has increased from Rs.16 billion to Rs.137 billion but its size is still very tiny when

compared with international market (Afza & Rauf, 2009). According to Khorana, Servaes &

Tufano (2005) Pakistan holds only 1.33% mutual fund assets to primary securities, in contrast to

India with 3.7%, Malaysia 4.0% and South Korea 16.5%. Mutual fund sector has potential to

grow but its success can be achieved through stringent regulations and better performance. This

will lead to increase in the popularity of mutual funds in Pakistan

Literature Review

At one time, investors used to evaluate the performance of mutual funds only on the basis

of returns. They were aware of risk but had not any measure to quantify risk. Although

development in portfolio theory in early 1960’s showed investors how to quantify risk but still

no measure combined risk and return the two factors had to be considered separately as

researchers such as [ CITATION Fri70 \l 1033 ] had done in early studies.

Treynor (1965) developed first composite measure to evaluate the performance of

portfolios that included risk and defined risk as β that indicated portfolio’s relative volatility. He

maintained two components of risk on one side it considered risk due to fluctuations in market

portfolio that is systematic risk and on another side it took into consideration the risk due to

fluctuations in the securities of portfolio.

Sharpe (1966) developed another measure which is known as Sharpe’s index to measure

portfolio’s performance. Sharpe took into consideration the other way of risk i.e. standard

deviation which measures the risk adjusted return of a portfolio.

PERFORMANCE OF PAKISTANI CLOSED ENDED MUTUAL FUNDS
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Another study was conducted by [ CITATION Jen67 \l 1033 ] in which he derived another

risk adjusted measure to evaluate the performance of mutual funds which is known as Jensen’s

Alpha. This measure first time measured the absolute performance of portfolios but it is based on

capital asset pricing model derived by (Sharpe, 1964).

[ CITATION Elt96 \l 1033 ] conducted a study by applying modern portfolio theory

techniques to examine the predictability for stock mutual funds using risk-adjusted returns. They

found that past performance is predictive of future risk-adjusted performance. They used USA

data and concluded that on average mutual funds underperformed the market by an amount

which is charged by funds manager form investors.

In our country, the sector of mutual funds is a victim of lack of attention on academic

basis. Although this sector has been introduced by 1962 yet there are only four papers which

have been published regarding mutual funds and their performance.

Shah & Hijazi (2005) conducted a research to evaluate the performance of Pakistani

mutual funds for a period 1997-2004 by using risk adjusted mutual funds performance models

and gave an overview of mutual funds industry of Pakistan and concluded that Pakistani mutual

funds are in growing phase. They also argued that most of mutual funds outperformed the market

portfolio and some mutual funds underperformed the market due to diversification problems.

The authors also pointed out that Pakistani mutual fund have potential to add value if savings of

the individuals are properly mobilized to the investors by offering a wide variety of mutual

funds.

Cheema and Shah (2006) worked on defining the role of mutual funds and non-banking

financial institutions and viewed the legal and corporate environment in which both work. The
PERFORMANCE OF PAKISTANI CLOSED ENDED MUTUAL FUNDS
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authors concluded that proper regulatory frame work can enhance the performance of Pakistani

mutual funds in particular and institutional investor in general and they can play a vital role in

corporate governance.

Another study has been conducted by [ CITATION Sip06 \l 1033 ] to evaluate the

performance of mutual funds in Pakistan for the period of 1995-2004 using Sharpe, Treynor and

Jensen measures to evaluate portfolios and the results showed that most of the mutual funds

underperformed the market portfolio except one. The author is of the opinion that Pakistani

mutual funds have not played any significant role in stock exchange and probably due to this

reason nothing has been written about them in academic journals.

Afza and Rauf (2009) wrote an article with a view to provide a guide line to the fund

manager of open-end mutual funds by drawing their attention to various attributes that may

influence the performance of mutual funds. The writers analyzed open-ended mutual funds for

the years 1999-2006 using Sharpe ratio coupled with pooled time series- and cross-sectional data

and resulted that lagged return, liquidity and 12 B-1 had significant impact on the influence on

open –ended mutual funds of Pakistan.

Data and Methodology

Research Problem

The question behind this study is that had closed ended mutual funds performed better

than market portfolio in period 2003-2007 or not. To analyze this problem this two measure have

been applied so far to evaluate the performance of the mutual funds.

Research Objective
PERFORMANCE OF PAKISTANI CLOSED ENDED MUTUAL FUNDS
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The main objective of this study is to measure the efficiency of closed ended mutual

funds’ managers that can be determined through their performance evaluation and making a

comparison not only among each other rather with market portfolio i.e. stock exchange. I have

tried to meet this objective by applying risk adjusted performance measure composites.

Sources of Data

Monthly returns on share prices of fourteen close ended funds for the period from 2003 to

2007 have been used to accomplish research objective i.e. their performance evaluation. For this

purpose different sources have been used: Asset management companies of the funds, stock

exchanges, SECP and internet. Data for Treasury bills rate was collected from statistical bulletins

of State Bank of Pakistan.

Variables

Variables picked for the performance evaluation of mutual funds are monthly returns on

certificate/share, monthly returns of KSE 100 index. Six months Treasury bill rates. Return of

fund was calculated dividing price at end of month by opening value per share. Annual dividends

on these funds should be taken into consideration to calculate return, but as returns have been

taken on monthly basis so it is assumed that the effect of dividends is being reflected in market

price.

Methodology

To evaluate the performance of mutual funds two risk adjusted composite measures have

been employed hence both definitions of risk have been used. These models are so famous that
PERFORMANCE OF PAKISTANI CLOSED ENDED MUTUAL FUNDS
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almost every text book on portfolio management takes them in to consideration. First of them is

[ CITATION Wil66 \l 1033 ] which reveals risk in term of standard deviation that is diversifiable risk

and mathematical expression of this model is

R p−Rf
Sr ¿
σp

Where Sr = Sharpe’s Ratio

Rp= Return of mutual fund

Rf = Risk free rate of return

σp= Standard deviation of mutual fund

Sharpe’s index measures risk premium of a mutual fund relative to per unit of portfolio’s

total amount of risk. The larger the Sr the better the mutual fund has performed.

The other measure which has been used in this study to evaluate the performance of

mutual funds is index of [ CITATION Tre65 \l 1033 ]. This composite measure adjusts the other type

of risk which is non diversifiable risk or systematic risk known as β. Treynor’s index is

R p−Rf
Tr ¿
βp

Where Tr = Treynor’s Ratio

Rp= Return of mutual fund

Rf = Risk free rate of return

βp = beta coefficient of mutual fund

PERFORMANCE OF PAKISTANI CLOSED ENDED MUTUAL FUNDS
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Treynor’s ratio measures the risk premium of a mutual fund relative to per unit of total

market risk which is non diversifiable in nature. Same like Sharpe’s ratio, risk aversive investors

like to enlarge its value because greater the value of Tr means mutual funds has performed better

and vice versa. The performance can also be explained by a characteristic line which was

developed by [ CITATION Tre65 \l 1033 ]

Empirical Results

The study computes of the ratio of the historical returns, (ex-post returns) in excess of the

risk-free rate to the standard deviation of the portfolio returns of the funds for the period from

2003 to 2007. Weighted average of six months Treasury bills rate was used as a risk free rate.

Results show that some of the funds have negative Sharpe ratio which indicate the managers’

inability in diversification but on overall basis Sharpe ratio of most of the funds is slightly higher

when compared to market which is risk premium of per one percent of standard deviation which

shows better performance as compared to market.

Treynor Ratio indicate that the portfolio offering the highest reward/risk (systemic risk)

ratio will be the only risky portfolio in which investors will choose to invest. The assumption is

that the portfolio manager has diversified away the diversifiable risk (unsystematic risk/company

specific risk) and the matter of concern for the investor should be the systematic risk (non-

diversifiable/market risk) only, instead of total risk. I computed the ratio of the historical returns,

in excess of the risk-free rate (T-Bill rate) to the systemic risk of the portfolio returns of the

Pakistani funds for the period from2003 to 2007. Results show that all funds have beta less than

1, in some cases significantly less than 1; regarding systemic risk we can conclude that all

mutual funds are defensive in their movement of returns as compared to the market returns (KSE
PERFORMANCE OF PAKISTANI CLOSED ENDED MUTUAL FUNDS
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100 index). Treynor ratio on overall basis/industry is 0.13 risk premium of per one percent of

systemic risk show reasonable risk premium per one percent of systemic risk. If the diversifiable

risk which is company specific is fully diversified away by the fund’s portfolio manager, the

results of Sharpe ratio and Treynor ratio are same. Our funds are facing the diversification

problem that is why the results of both ratios are not the same.

Conclusion

This paper provides an overview of the Pakistani mutual fund industry and investigates

the mutual funds risk adjusted performance using mutual fund performance evaluation models.

The performance of these funds cannot be considered to be very good relative to the market

portfolio. These results are however, not different from results of studies conducted over much

longer periods in US and Europe. There also a small proportion of funds (approximately 30

percent) beat the market in a given period, but the compositions of these market beaters kept on

changing from period to period, thus suggesting no special competency on the part of the mutual

funds to consistently beat the market.

Overall results suggest that mutual funds in Pakistan are able to add value. Whereas

results also show some of the funds under perform, these funds are facing the diversification

problem. Worldwide there had been a tremendous growth in this industry; this growth in mutual

funds worldwide is because of the overall growth in both the size and maturity of many foreign

capital markets, we are far behind

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References

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Econmic and Social Review , 47 (2), 199-214.

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Performance and Investment Style. Journal of Banking & Finance , 29, 1751–1767.

Cheema, M., & Shah, S. A. (2006). The Role of Mutual Funds and Non-Banking Financial

Companies in Corporate Governance in Pakistan. Centre for Management and Economic

Research (CMER) Working Paper No.06-46 Lahore University of Management Sciences .

Elton, E. J., Gruber, M. J., & Blake, C. R. (1996). The Persistence of Risk-Adjusted Mutual Fund

Performance. Journal of Business , 69 (2), 133-57.

Fischer, D. E., & Jordan, R. J. (2006). Security Analysis and Portfolio management (6th Edition

ed.). Pearson Education, Inc.

Friend, Irwin, Bloom, M., & Crockett, J. (1970). Mutual Funds and other Institutional Investors.

New York: McGraw-Hill.

Jensen, M. C. (1967). The Performance Of Mutual Funds in the Period 1945-1964. Journal of

Finance , 23 (2), 389-416.

Khorana, A., Servaes, H., & Tufano, P. (2005). Explainig the Size of Mutual Fund Industry
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around the World. Journal of Fianancial Economics .

Orman, S. (2007). Ask Suze ... About Mutual Funds and Annuities. New York: River Head Books

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Rao, S. N., & Ravindran, M. (n.d.). Performance Evaluation of Indian Mutual Funds.

Shah, S. M., & Hijazi, S. T. (2005). Performance Evaluation of Mutual Funds in Pakistan. The

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Sharpe, W. F. (1964). Capital Asset Prices A Theory of Market Equilibrium Under Conditions of

Risk. Journal of Finance , 19 (3), 425-442.

Sharpe, W. F. (1966). Mutual Fund Performance. Journal of Business , 39 (1), 119-138.

Sipra, N. (2006). Mutual Fund Perofrmance in Pakistan, 1995-2004. Centre for Management

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Economic Research (CMER) Working Paper No. 06-45 Lahore University of

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T-bill Rates. (n.d.). Retrieved March 10, 2010, from State Bank of Pakistan Web site:

http://www.sbp.org.pk/ecodata/tb.pdf

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Mutual funds. (n.d.). Retrieved March 14, 2010, from Karachi Stock Exchange Web site:

http://www.kse.com.pk/text/mutualFund.pdf

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PERFORMANCE OF PAKISTANI CLOSED ENDED MUTUAL FUNDS
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Table 1

  Mean Std. Treynor’s Sharpe's

Deviation β Ratio Ratio
 

AL-Mezan Mutal 0.191838 0.1413628 0.59 0.10469 -0.4369

0.039090
0.2422023
Asian Stocks 6 0.103 0.4064 -0.1728
Atlas Fund -0.001938 0.1290677 0.184 0.45048 -0.6422
0.024309
0.1829426
F.Cap.Mut.Fund 6 0.037 1.53082 -0.3096
First Dawood Mutual Fund 0.19689 0.108977 0.0255 -3.0973 -0.7247
Golden Arrow 0.129252 0.1824141 0.005 -3.605 -0.3729
0.270691
0.3227453
Investic Mutual 6 0.097 0.415 -0.1247
Meezan Bal Fund 0.175672 0.2323808 0.028 2.26367 -0.2728
Pak. PremierFund 0.269379 0.1500522 0.095 0.56855 -0.36
0.004295
0.092922
Pakistan Strategic 1 0.237 0.32344 -0.8249
PICIC Growth -0.029532 0.1355929 0.142 0.77804 -0.8148
PICIC Inv.Fund 0.192784 0.3705366 0.295 0.1616 -0.1287
Prudential’s. Fund Ltd. 0.224987 0.3335585 0.03 0.61504 -0.0553
0.103825
  0.3394456
Tri-Star Mutual 9 0.044 0.51991 0.06739