Performance Evaluation Report

Reference Number: PPE: PHI 2011-16 Project Number: 28714 Equity Investment Number: EI 7125-PHI July 2011

Philippines: The Mutual Fund Company of the Philippines

This report contains information that is subject to disclosure restrictions agreed between ADB and the relevant sponsor or recipient of funds from ADB. Recipients should therefore not disclose its content to third parties, except in connection with the performance of their official duties. ADB shall make publicly available an abbreviated version of this report that will exclude confidential information.

Independent Evaluation Department

CURRENCY EQUIVALENTS (as of April 2011) Currency Unit P1.00 $1.00 – = = Philippine peso (P) $0.231 P43.290

ABBREVIATIONS ADB ATRKE BSP CFMA CIS CTF CTRP ECC EROIC ESG FIRR FMAP GDP ICAP MFCP MFMCP PDEX PNB PPER PSE ROIC RRP SDA SEC UITF – – – – – – – – – – – – – – – – – – – – – – – – Asian Development Bank ATR KimEng Asset Management, Inc. Central Bank of the Philippines Clemente Fund Management Asia collective investment scheme common trust fund Comprehensive Tax Reform Program environmental clearance certificate economic return on invested capital environmental, social, and governance financial internal rate of return Fund Managers Association of the Philippines gross domestic product Investment Company Association of the Philippines Mutual Fund Company of the Philippines Mutual Fund Management Company of the Philippines Philippine Dealing and Exchange Corporation Philippine National Bank project performance evaluation report Philippine Stock Exchange return on invested capital report and recommendation of the President special deposit account Securities and Exchange Commission (Philippines) unit investment trust fund NOTES (i) (ii) The fiscal year of the Mutual Fund Company of the Philippines ends on 31 December. In this report, "$" refers to US dollars. Key Words adb, asian development bank, capital market, equity investment, fund management, lending, investment company, mutual fund, mutual fund company of the philippines, philippines, private sector, securities, stock market.

Director General Director Team leader Team members

H. Hettige, Officer-in-Charge, Independent Evaluation Department (IED) H. Feig, Officer-in-Charge, Independent Evaluation Division 1 N. Subramaniam, Senior Evaluation Specialist (Private Sector), IED N. Gamo, Evaluation Officer, IED I. Garganta, Senior Evaluation Assistant, IED Independent Evaluation Department, PE-744

In preparing any evaluation report, or by making any designation of or reference to a particular territory or geographic area in this document, the Independent Evaluation Department does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS Page BASIC DATA EXECUTIVE SUMMARY I. THE PROJECT A. Project Background B. Key Project Features C. Progress Highlights EVALUATION A. Project Rationale and Objectives B. Development Impact C. ADB Investment Profitability D. ADB Work Quality E. ADB Additionality F. Overall Evaluation ISSUES, LESONS, AND RECOMMENDED FOLLOW-UP ACTIONS A. Issues and Lessons B. Recommended Follow-up Actions i 1 1 2 2 3 3 4 14 14 16 16 17 17 18

II.

III.

APPENDIXES 1. Mutual Fund Industry Developments 2. Private Sector Development Indicators and Ratings 3. Review of the Fund 4. Capital Market Overview

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The guidelines formally adopted by the Independent Evaluation Department (IED) on avoiding conflict of interest in its independent evaluations were observed in preparing this report. Consultant Lisa Taber assisted in the analysis and preparation of the report. To the knowledge of the management of IED, the person preparing, reviewing, or approving this report had no conflict of interest.

BASIC DATA The Mutual Fund Company of the Philippines (Equity Investment 7125-PHI) As per ADB Investment Documents Actual

Key Equity Investment Data ($ million) Approved Amount Subscribed Amount Key Dates Approval of Concept Clearance Fact-Finding Management Review Meeting Staff Review Committee Meeting Board Approval Signing Date of Legal Documents Disbursement Date

$3.85 million $3.85 million

$3.85 million $3.85 million Actual September 1995 29 November 1995 24 January 1996 9 April 1996 15 April 1996 29 April 1996

EXECUTIVE SUMMARY In April 1996, the Asian Development Bank (ADB) made an equity investment of P100 million (then equivalent to $3.85 million) in the Mutual Fund Company of the Philippines (MFCP), a new, open-end growth and income (balanced) fund investing only in the Philippines and primarily in listed equities and fixed-income instruments of Philippine companies, as well as in government debt obligations. The main objective of the investment was to catalyze the development of the nascent mutual fund industry in the Philippines and attract small savers to the market, thereby increasing the domestic supply of capital for investment and growth. ADB’s investment in MFCP was also expected to foster the development of secondary markets for debt and equities. ADB and six other founding shareholders invested a total of P430 million in MFCP before it was opened to public participation on 1 May 1996. Combining sales to individuals and institutional investors, the MFCP was targeting a fund size of P1.2 billion, according to the report and recommendation of the President (RRP) of the proposed equity investment in the MFCP. About a year after MFCP’s launch, Philippine markets were struck by a series of economic, political, and global shocks, the effects of which would not abate for 6 years. The Asian financial crisis first caused a severe economic contraction in 1997–1998. After a brief rebound, Philippine markets were hit again by high levels of political instability (including a presidential impeachment), serious revelations of stock-market fraud, growing macroeconomic imbalances, a huge devaluation of the peso, and global events—including the bursting of the tech-stock bubble in 2000 and the 9/11 terrorist attacks in the United States in 2001. While these conditions affected market performance broadly, MFCP’s results were generally more negative than those of other balanced funds or the benchmark index. By 2002, MFCP’s net assets had eroded to less than half their initial value due to investment losses, large redemptions from institutional investors (themselves under financial stress), and disappointing share sales. The Mutual Fund Management Company of the Philippines (MFMCP), MFCP’s first fund manager, saw its capital fall below statutory requirements. As a result, in August 2003 it was forced to sell a controlling stake in MFMCP to ATR KimEng Asset Management, Inc. (ATRKE), part of a family of global financial services companies in Asia. Despite these initial problems, MFCP’s fund manager has helped expand mutual funds by participating in industry efforts to lobby the government for key regulatory reforms. Two of the major hurdles to the growth of mutual funds identified in the RRP—rules that effectively doubletaxed capital gains on mutual funds and that prevented fund managers from managing more than one fund—were eliminated in 1998. Since then, net mutual fund assets have grown by a factor of nearly 40. Since 1996, gross national savings have also increased dramatically, from about 18% to 40%. The bond market has grown by 25% per year since 2000 and corporate issues have increased from 2% to 12% of trades. However, serious deficiencies in the regulatory framework have not been rectified. The regulatory and taxation rules that apply to various types of similar longer-term investments are very different. Companies and customers have to disentangle a complex web of rules before they can decide what to offer or purchase. MFCP made only minimal contributions to the development of the mutual fund industry, to retail investor outreach and to the capital market development in the Philippines. Nevertheless, the patience of ADB as an investor in MFCP, which allowed for the continued presence of MFCP in the market, helped bring a degree of stability to the mutual fund industry at a very fragile time and enabled the entrance of ATRKE into the market. ATRKE has since

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earned competitive returns, set high standards for mutual fund operations, and been a leader in the industry’s efforts to hold companies listed on the Philippine Stock Exchange (PSE) to higher governance standards. The project’s private sector development impact is rated partly satisfactory (All ratings are evaluated based on the criteria established in ADB's Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations [2007]). Though ATRKE has improved performance since the takeover, MFCP has earned a return on invested capital of 3.22% since inception, compared with a compound annual growth rate of 5.62% for the benchmark index for balanced mutual funds. The project’s business success is rated unsatisfactory. ATRKE has not been able to grow MFCP’s capital base beyond its original amount, ending 2010 with only P500 million in net assets (while the industry has grown from P2.4 billion to P95.6 billion), nor has MFCP achieved substantial outreach. In 1998, the fund comprised 27% of all mutual fund accounts in the Philippines, but only 2% in 2010. Thus MFCP has had little impact on the participation of small investors in the mutual fund market. The economic rate of return on invested capital (EROIC) for the MFCP investment is calculated by using the return on invested capital and adjusting for fees and taxes paid. The real EROIC for the project equals 0.26%, and since it is lower than the 5% set by ADB's guidelines, the contribution to economic development of the operation is rated unsatisfactory. The subscription agreement signed between ADB and MFCP on 15 April 1996 requires the fund manager to review an investee’s level of compliance with environmental laws, regulations, and standards—including those relating to environmental impact assessments and involuntary resettlement—before it purchases any security for the first time or when making subsequent purchases. MFMCP and ATRKE have complied with the requirement to review an investee’s compliance with environmental laws, regulations, and standards by periodically obtaining a list of environmental clearance certificates provided by the Environmental Management Bureau, and making sure that a certificate has not been denied to any company in which the fund has an equity position. Given the ratings described above for private sector development, business success, contribution to economic development, and environmental, social, health, and safety performance, the project’s overall development impact is rated partly satisfactory. In April 1996, the value of ADB’s investment in MFCP was P100 million (equivalent to $3.85 million at the time). As of 31 December 2010, the value of ADB’s investment was P168 million ($3.83 million equivalent), which generates a financial internal rate of return (FIRR) of –2.1% in real pesos and –0.04% in dollars. According to ADB guidelines, since these returns are lower than 0.7 times the expected net FIRR of 23% in dollar terms in the RRP, the project is rated unsatisfactory for ADB investment profitability. ADB work quality is rated satisfactory. The initial design of the investment underestimates the effects of tax and regulatory disadvantages. The project’s RRP places emphasis on the fund’s expected benefits to small savers, but does not define this group or set any targets by which to measure success. The RRP also overestimates the returns the investment would achieve. However, while the rationale for the project and its initial design suffered from overly optimistic assumptions, the operation was a rather unique attempt on the part of ADB to intervene proactively in a severely underdeveloped and key part of the financial system, and screening, appraisal, and structuring are rated partly satisfactory.

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After the investment had been made, ADB was very engaged in oversight—attending board meetings and keeping close track of the fund and the fund manager. Project records show frequent communication between the fund and ADB staff seeking to clarify data or asking for additional information. Anticipating its eventual divestiture, ADB resigned its board seat in 2006 but continues to participate as an active board observer. Monitoring and supervision are rated satisfactory. ADB’s long investment in MFCP has contributed to the fund’s survival and prevented a more serious industry free-fall in 1997. ADB also reportedly encouraged MFCP to develop the comprehensive operations manual that was used by the Securities and Exchange Commission of the Philippines to assist other companies in the process of setting up mutual funds; to fully disclose risks to potential investors in the prospectus; and to adopt a code of ethics. ADB's role and contribution are thus rated satisfactory. ADB’s investment probably played an important role in getting MFCP off the ground in 1996. ADB was one of the largest and most respected of MFCP’s founding shareholders and its participation may have been key, in early 1997, to attracting other investors. ADB’s additionality is rated satisfactory. There are still many barriers to the development of the mutual fund industry in the Philippines. Foremost among them is the lack of a transparent and equitable regulatory environment due to the extremely opaque and uneven treatment of different but very similar types of competing mutualized investment products, including mutual funds, trusts, insurance, and pre-need products such as college saving plans. Also, lack of financial understanding is perceived as a key constraint to the growth and widespread consumer uptake of mutual funds. Personal investment is still a new concept in the Philippines and consumers lack basic knowledge about the safety, liquidity, and potential returns of different investment options. The following actions are recommended to follow up on the goals and achievements of the MFCP investment: (i) ADB’s exit from MFCP should be gradual. ADB controls a large share of the fund’s net assets (34%). Abrupt divestment would cause a precipitous drop in ATRKE’s fee income, which could hurt its ability to manage the fund. It could also alarm other investors and trigger a wave of fund redemptions. Any future ADB policy analysis and dialogue on capital market development in the Philippines could include issues relevant to the development of the mutual fund industry.

(ii)

Hemamala S. Hettige Officer-in-Charge Independent Evaluation Department

I. A. Project Background

THE PROJECT

1. In April 1996, the Asian Development Bank (ADB) made an equity investment of P100 million (then equivalent to $3.85 million) in the Mutual Fund Company of the Philippines (MFCP), a new, open-end growth and income (balanced) fund investing only in the Philippines and primarily in listed equities and fixed-income instruments of Philippine companies, as well as in government debt obligations. The main objective of the investment was to catalyze the development of the nascent mutual fund industry in the Philippines and attract small savers to the market, thereby increasing the domestic supply of capital for investment and growth. ADB’s investment in MFCP was also expected to foster the development of secondary markets for corporate debt and equities. 2. When the investment was approved, there were only six other mutual funds operating in the Philippines. Net mutual fund assets totaled less than 0.01% of gross domestic product (GDP). Industry growth had long been stifled by restrictive regulations, and the Securities and Exchange Commission (SEC) of the Philippines suspended new licensing altogether in the 1970s because of unsuitable market conditions. Not until 1989 were rules issued that permitted the establishment of new mutual funds, but unfavorable tax and regulatory treatment limited the market to very few entrants. 3. In 1994, Clemente Capital, a successful asset management company based in New York and founded by a Filipina national, Ms. Lilia Clemente, approached ADB with the prospect of investing in MFCP. As part of an ongoing policy dialogue and program of support to the Philippine government, ADB was in the process of preparing a $150 million Capital Market Development Program Loan1 to address key regulatory issues that constrained the growth of stock and bond markets. The MFCP investment was viewed as an opportunity to complement the program of regulatory reforms by fostering the growth of mutual funds and stimulating trading on secondary markets. 4. ADB and six other founding shareholders invested a total of P430 million in MFCP before it was opened to public participation on 1 May 1996. The company that originally managed the fund—Mutual Fund Management Company of the Philippines (MFMCP)—was set up in July 1995. Clemente Fund Management Asia (CFMA), an affiliate of the New York-based Clemente Capital, contributed 35% of MFMCP’s initial capital, the Philippine National Bank (PNB), a state-owned commercial bank, put up an additional 35%, and two other institutional investors contributed the remainder.2 MFMCP earned standard fees equal to 2.15% of MFCP’s net assets in exchange for expanding the fund through new share sales, administering accounts, and managing fund assets.3

1

2 3

ADB. 1995. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the Republic of the Philippines for the Capital Market Development Program (Loan 1363). Manila. National Investment Trust of China and Japan's Daiwa Asset Management. MFMCP agreed to reduce the management fee component of its overall fee by 0.5% to 1.0% for the first year of operation to make the fund more attractive than its competitors. The other fee components include 0.5% for distribution and 0.15% for administration. After the first year, MFCP’s management fee went up to 1.5%, thus its total fee was and still is 2.15%.

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B.

Key Project Features

5. MFCP was launched in 1996 as an open-end mutual fund with the investment objectives of preserving shareholders’ principal, generating current income, and promoting long-term capital growth by investing in a balanced portfolio of equities and fixed-income securities issued by Philippine companies, and debt issued by the government. 6. MFCP was focused on selling to Filipinos, initially targeting share sales to small savers, or ordinary salaried employees. To reach this segment, MFMCP planned to pitch to individual members of large pension funds and build a network of money centers. 7. MFMCP also planned to sell through 12 branches of PNB and 8 branches of the Development Bank of the Philippines, and to open a network of its own branches, or money centers, throughout the country. In the long run, however, other large banks and a network of MFCP agents were expected to drive share sales. 8. The minimum investment required to open an MFCP account was set at P5,000 (equivalent to about $192 at the time of ADB’s investment), with subsequent share purchases available in P1,000 denominations. MFCP was also planning seminars and other outreach efforts to educate the public on the fund’s potential benefits and attract new investors. 9. Combining sales to individuals and institutional investors, MFCP was targeting a fund size of P1.2 billion. To prevent a large drop in net assets, ADB and the founding shareholders agreed not to divest their shares for two years. C. Progress Highlights

10. About a year after MFCP’s launch, Philippine markets were struck by a series of economic, political, and global shocks, the effects of which would not abate for 6 years. The Asian financial crisis first caused a severe economic contraction in 1997–1998. After a brief rebound, Philippine markets were hit again by high levels of political instability (including a presidential impeachment), serious revelations of stock-market fraud, growing macroeconomic imbalances, a huge devaluation of the peso, and global events—including the bursting of the tech-stock bubble in 2000 and the 9/11 terrorist attacks in the United States in 2001. 11. While these conditions affected market performance broadly, MFCP’s results—a net financial internal rate of return (FIRR) of –6.1% through late 2003—were generally more negative than those of other balanced funds or the benchmark index. MFCP’s net assets eroded to less than half the initial value due to investment losses, large redemptions by institutional investors (themselves under financial stress), and disappointing share sales. The fund manager, MFMCP, saw its capital fall below statutory requirements and was forced, in August 2003, to sell a controlling stake in MFMCP to ATR KimEng Asset Management, Inc. (ATRKE), part of a family of global financial services companies in Asia. 12. ATRKE has since improved fund performance, returning a net FIRR of 13.5% since the takeover and establishing a 10-year track record that is competitive with its peers. Since inception, however, the fund has achieved a net FIRR of 3.5%. The fund is also very small in terms of its net assets and shareholder base relative to several competitors that entered the market after MFCP.

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13. Despite disappointing net asset growth, MFCP has assisted the expansion of mutual funds by participating in industry efforts to lobby the government for key regulatory reforms. Two of the major hurdles to the growth of mutual funds identified in the report and recommendation of the President (RRP)—rules that effectively double-taxed capital gains on mutual funds and prevented fund managers from managing more than one fund—were eliminated in 1998. Since then, net mutual fund assets have grown by more than 30% per year (Appendix 1). Since 1996, gross national savings have also increased, from about 18% to 40% (Appendix4). 14. While ADB’s investment was not necessarily a causal factor in achieving the growth of mutual funds or of the national savings rate, its continued presence in the market brought a degree of stability to the mutual funds industry at a very fragile time, and enabled the entrance of ATRKE into the market. ATRKE has since earned competitive returns, set high standards for mutual fund operations, and been a leader in the industry’s efforts to hold companies listed on the Philippine Stock Exchange (PSE) to higher governance standards. 15. Anticipating its eventual divestiture, ADB resigned its board seat in 2006 but continues to participate as an active board observer. As of 31 December 2010, ADB’s investment in MFCP was worth P168 million (equivalent to $3.83 million) and the FIRR was –0.04% in current dollars. II. A. Overview EVALUATION

16. The project is evaluated using the criteria defined in ADB's guidelines. 4 The project rationale and objectives segment below outlines the objectives envisaged during the approval of the project. The investment is appraised according to (i) development impact and outcomes, (ii) ADB investment profitability, (iii) ADB work quality, and (iv) ADB additionality. An overall evaluation of the project performance is then presented. B. Project Rationale and Objectives

17. The main objective of ADB's investment in MFCP was to revitalize the Philippine mutual fund industry via a catalytic demonstration effect, with the overarching goal of mobilizing individual savings to help finance corporate investment and propel economic growth. ADB anticipated that its investment would achieve this objective by lending credibility to and enhancing public confidence in the industry, and that the success of MFCP would in turn spur the launching of other funds. The operation was also expected to foster the development of the secondary market for securities and fixed-income instruments by creating greater demand for such securities. 18. The RRP also anticipated that the fund would target small savers and show a broad segment of the population that a professionally managed and diversified mutual fund can offer superior returns to saving deposits. Achieving project objectives therefore depended on the fund achieving good returns relative to the market. As for the RRP's emphasis on targeting small savers, there is no explicit definition of a ―small saver‖.

4

ADB. 2007. Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations. Manila.

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C.

Development Outcomes and Impact 1. Overview

19. The overall development outcome and impact is rated partly satisfactory based on component ratings of partly satisfactory in private sector development; unsatisfactory in business success; unsatisfactory for contribution to economic development; and satisfactory for environmental, social, health, and safety performance. 2. Private Sector Development

20. The private sector development is appraised under two categories: beyond company impacts and direct company impacts. The private sector impacts of the project have been only partly satisfactory. Further details on private sector development indicators and ratings are in Appendix 2. a. Beyond Company Impacts

21. The project's beyond-company impacts are discussed under the stated objectives of contributions to mutual fund industry development and contributions to capital markets development in the Philippines. i. Contributions to Mutual Fund Industry Development (i) Size of Mutual Fund Industry

22. In 1996, MFCP was one of only seven mutual funds in the Philippines. When the Asian financial crisis struck the country, MFCP contributed to the stability of the mutual fund industry by staying in the market. The net assets of all mutual funds fell by 46% in dollar terms in 1997. At the end of that year, MFCP’s net assets accounted for 23% of the industry’s total. 23. MFCP saw its share of the mutual fund industry's total net assets decline to 0.5% by the end of 2010. While MFCP’s net assets have declined since 1996, the net assets of all mutual funds in the Philippines increased by a factor of nearly 40 (Appendix 1, Figure A1.1). The growth began in 1998 with the enactment of the Comprehensive Tax Reform Program (CTRP). In 2000, the pace of industry growth quickened even more after the Central Bank of the Philippines (BSP) issued a ruling that enabled mutual fund management companies to manage more than one fund.5 ATRKE has been able, therefore, to open four additional mutual funds in the Philippines, with a combined P1.3 billion in assets under management (versus an industry total of P95.7 billion). 24. Yet the mutual fund industry in the Philippines remains small relative to many countries in the region and has lagged its economic peer group (Appendix 1, Figures A1.2 and A1.3). While MFCP may have provided a measure of stability early on and enabled ATRKE to expand into new funds, its impact on the overall growth of the mutual fund industry has been minimal. The catalytic and demonstration effects of the fund were limited due to its poor performance but, as discussed above, the real constraint on industry growth was the lack of a transparent and equitable tax and regulatory system.
5

Because investors have different goals and risk appetites, management companies that offer various types of funds (e.g., balanced, stock, bond, and money market funds) can attract more investment and leverage their personnel and infrastructure to achieve greater economies of scale.

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(ii)

Outreach to Retail Investors

25. The mutual fund industry principally needs educated investors and the infrastructure to reach them efficiently. Personal investment is still a new concept in the Philippines and consumers know little about the safety, liquidity, and potential returns of different investment options. The lack of financial understanding prevents widespread consumer uptake and thus limits the growth of mutual funds in the Philippines. 26. The number of mutual fund accounts is a good proxy for the number of investors. In the Philippines, the number of accounts has grown from approximately 2,800 in 1998 to 106,000 in 2010.6 While growth has been steep, the country was starting from a tiny investor base and the number of mutual fund accounts in the Philippines remains very small as a proportion of the population (one-tenth of 1%). 27. MFCP’s contribution to the growth of accounts was minimal, and it had little impact on the participation of small investors in the mutual fund market. The fund accounted for 27% of all mutual fund investment accounts in 1998, but MFMCP (the original fund manager) was unable to attract and retain more than 1,000 investors by the end of 2003. By that same time, the industry had grown to more than 50,000 accounts. ATRKE has since increased the number of MFCP accounts to nearly 2400 in 2010, but this is still a very small number and amounts to only 2% of total mutual fund accounts. Under ATRKE’s management, MFCP is trying to increase its number of retail investors through direct selling, seminars, the internet, schools, and other educational efforts. (iii) Impact on Regulation and Policy

28. In the first 18 months after its inception, MFCP joined forces with other members of the Investment Company Association of the Philippines (ICAP) to persuade the government to pass the CTRP, which was enacted in 1998. The CTRP eliminated double taxation of mutual fund profits and thus opened the door to a period of sustained industry growth. ICAP also played an important role in securing the right for fund managers to manage a family of mutual funds, rather than just a single fund, making mutual fund management a much more viable business. MFCP thus partly contributed to achieving critical reforms of mutual fund regulation and taxation. 29. The market for mutual funds in the Philippines remains stunted, however, because serious deficiencies in the regulatory framework have not been rectified. The regulatory and taxation rules that apply to similar longer-term investments—including mutual funds, unit investment trust funds (UITFs), insurance products, or pre-need products such as instruments to invest for a child’s college education—vary for each product (see Appendix 1). Companies and customers have to disentangle a complex web of different advantages and disadvantages to decide which one of a set of very similar products to offer or purchase. 30. For more than 15 years members of the industry have been working with the government to develop harmonized regulations for mutualized investment products. Their most recent efforts are manifest in the proposed collective investment scheme (CIS) law. Despite longstanding acknowledgement that reforms are needed to enable fair competition, the development of the Philippine mutual fund industry is still constrained by the lack of an equitable regulatory environment.
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Data provided by the Investment Company Association of the Philippines.

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ii.

Contributions to Capital Markets Development (i) Stock Market Development

31. The increase in mutual funds and domestic savings in the Philippines has not translated into greater stock-market volume or depth. Although it has been very volatile, the PSE’s market capitalization as a percentage of GDP has trended downward over the past 15 years, reaching a peak of 97% in 1996 and falling to a low of 31% in 2008 (Appendix 4, Figure A4.3). In contrast, the size of the stock market relative to economic output trended upward in East Asia and the Pacific region, and for lower-middle-income countries worldwide (Figure A5.3). At the end of 2009, the stock-market capitalizations of these peer groups relative to GDP were more than 30 percentage points higher than in the Philippines. 32. The number of companies listed on the PSE has grown very little since ADB invested in MFCP, from about 210 to 250 companies, making it one of the smallest listings on any market in Asia (Figure A4.4). Thus the growth in the mutual fund industry does not seem to have had an appreciable impact on the development of the stock market in the Philippines. 33. Also, while investors have little choice of companies to include in their portfolios, they are further limited by the liquidity of the stocks issued. The volume of shares traded as a percentage of total shares listed on the PSE was slightly lower in 2009 than in 1995, and is markedly lower than in other Asian economies and in lower-middle-income countries worldwide (Figure A5.5). 34. Issues of corporate governance and ownership concentration are often cited among the likely explanations of why the Philippine stock market has remained so underdeveloped. (ii) Bond Market Development

35. Figure A4.6 in Appendix 4 shows end-of-year data for the amount of corporate and government bonds outstanding as a portion of GDP in the Philippines and nine other Asian countries from 2000 to 2010.7 The size of other Asian bond markets relative to domestic output varies greatly— from 8% in India and 12% in Viet Nam8, to 51% in the People's Republic of China, 67% in Thailand, 96% in Malaysia, and 190% in Japan. 36. The Philippines remains on the lagging end of this spectrum, but its bond market has grown by about 25% per year since 2000. Only 12% of this debt is corporate rather than government issued (Figure A5.7), compared with 9% in Viet Nam, 20% in Thailand, and 45% in Malaysia. Corporate issues in the Philippines have increased since 2005, when the Philippine Dealing and Exchange Corporation (PDEX) opened as a secondary market for government and private debt securities.

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Government bonds include obligations of the central government, local governments, the central bank, and stateowned entities. Corporate bonds comprise issues by both public and private companies, including financial institutions and international organizations. 8 The relative immaturity of the Indian bond market is largely explained by its deficiencies with respect to ―disclosure policies, bankruptcy processes, consolidation of government benchmark issues, and regulatory structures,‖ as per a paper published by ADB: S. Wells and L. Schou-Zibell. 2008: India’s Bond Market—Developments and Challenges Ahead. Manila. Viet Nam’s corporate bond market was non-existent until 5 years ago, and the volume of tradable government debt remains very small.

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37. So, while it remains relatively small compared with some Asian economies, the Philippine bond market has grown steadily since 2000 and prospects for further deepening of corporate issues are good. Thus the growth in balanced mutual funds such as MFCP will likely further contribute to the growth of the bond market. 38. However, mutual fund companies report that more transparency is needed regarding the companies that issue bonds, for analysts to be able to properly rate and recommend their private debt offerings. A more active government market with longer maturities on which to price corporate issues will contribute to the development of the bond market. (iii) Growth of Domestic Savings

39. The RRP for ADB’s investment in MFCP points to an average ratio of gross domestic savings to GDP of 18.6% during 1991–1994. The RRP notes that a well-ordered and efficient mutual fund industry will enhance the scope and diversity of investment management products and services, promote a higher level of domestic savings, and draw capital from areas of the economy with excess liquidity to those with inadequate capital. 40. Gross domestic savings in the Philippines have expanded significantly since ADB’s investment in MFCP, more than doubling to 40% in 2009 (Appendix 4, Figure A4.2). The extent to which increased savings have been invested in domestic capital markets is unclear. Mutual fund net assets amounted to only 2.4% of national savings in 2009, so only a small portion of the increase in savings has been invested in mutual funds. Due to its poor performance and its lack of substantial investor outreach, MFCP has had minimal impact on any increase in savings deployment in mutual fund assets. b. Direct Company Impacts

41. ATRKE has introduced robust analytical practices and investment policies. For instance, it is one of just a few mutual fund management companies in the Philippines using Bloomberg’s Asset and Investment Manager system. This platform integrates with Bloomberg’s data products to provide ATRKE with a rich source of constantly updated information and the tools to take advantage of it quickly—tools for executing trades, tracking and analyzing portfolio positions, and managing risk and compliance.9 42. ATRKE’s rigorous approach to investment screening and its use of Bloomberg's Asset and Investment Manager system sets it apart from most of its competitors. Employees who train in the use of these tools become assets for other mutual fund management companies, given their valuable knowledge and practical skills from their employment at ATRKE. 43. MFCP is credited with having developed a fully documented operations manual at its outset that was used by the SEC to assist other companies in the process of setting up mutual funds. MFCP reportedly also led the industry by publishing its results based on longer-term returns rather than just daily returns, and by adherence to a code of ethics. 44. More recently, ATRKE’s managing director has become president of the Fund Managers Association of the Philippines (FMAP), an industry organization that includes trusts and insurance companies as well as mutual funds. Under ATRKE’s leadership, FMAP is making efforts to improve corporate governance among investee companies. Thus, MFCP has made
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Available: http://www.bloomberg.com/solutions/bloomberg_enterprise/trading_solutions/

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valuable contributions to promoting corporate governance and improving reporting standards in the mutual fund industry. 3. Business Success a. Market Context

45. MFCP has been affected by dramatically different economic, political, and global events, which map to the two periods in which the fund was managed first by the MFMCP then by ATRKE. 10 During the difficult investment climate that prevailed from 1997–2002, the fund was managed by MFMCP. When the Asian financial crisis hit the Philippine economy in 1997, MFCP produced negative returns for the year, as did market benchmarks and most balanced funds (Figure 1).

Figure 1: Annual Returns MFCP, Blended Index and Phisix
80.0% 60.0% 40.0% 20.0% 0.0% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 -20.0% -40.0% MFCP -60.0%
MFCP = Mutual Fund Company of the Philippines. Sources: Philippine Stock Exchange fact books and annual reports; Bureau of Treasury; Bangko Sentral ng Pilipinas, Private Sector Operations Department records, ATR KimEng Asset Management, Inc..

Blended index

Phisix

b.

MFMCP Performance

46. From 1996–2003, MFCP’s generally negative results compared with the market were, in large part, the product of poor investment decisions. Until the third quarter of 1998, the chief investment officer at Clemente Capital headquarters in New York made all investment decisions, which MFMCP personnel in Manila would execute. Given the volatile market conditions and the difference in time zones, making investment decisions was difficult.

10

See Appendix 3 for more details on the fund’s history and performance.

2010

9

47. Clemente Capital eventually authorized the Manila-based president of MFMCP to make investment decisions on a day-to-day basis, and adjusted its investment strategy. However, by the time these changes were made, the accumulation of investment losses had contributed to the erosion of MFCP’s capital base. The fund had P560 million in net assets at the end of 1996; by the end of 1998, it had little more than half that amount (Figure 2).

Figure 2: MFCP Net Assets (P million)
700 600 500 400 300 200 100 -

2003

2008

1996

1997

1998

1999

2000

2001

2002

2004

2005

2006

2007

2009

MFCP = Mutual Fund Company of the Philippines. Source: Investment Company Association of the Philippines.

48. The decline in MFCP’s net assets was also due to the complete divestiture, in 1998, of two founding shareholders: the retirement funds of the San Miguel Corporation and the Armed Forces of the Philippines. They withdrew from MFCP because they themselves came under financial strain from the Asian financial crisis. Together, these institutions held about 40% of MFCP’s subscribed shares. 49. While MFCP improved its performance in 1999, the relatively positive results did not continue. MFMCP realized in 2000 that the Philippine markets were facing a bleak outlook due to serious macroeconomic and governance problems. International investment advisors like ING Baring had rated Philippine stock markets as underweight—meaning that investors should sell rather than buy Philippine equities. In August of 2000, MFMCP sought the support of MFCP’s board of directors to change the fund’s investment policy that restricted investment in securities outside of the Philippines. ADB’s board representative expressed concern that such a change would run counter to the fund’s objective of stimulating development in the Philippines. The question was tabled and apparently never reconsidered. While the ability to better diversify might have helped the fund, MFCP underperformed the country’s blended index in 2000–2002.

2010

10

50. In part due to its investment performance, MFCP had disappointing net sales after the major sell-off in 1998, through to 2003. Figure 3 shows the amount of MFCP shares sold in any given year, minus the amount redeemed, which equals net sales.11

Figure 3: MFCP Net Sales (P million)
150.0 100.0 50.0 1997 (50.0) (100.0) (150.0) (200.0) (250.0) MFCP = Mutual Fund Company of the Philippines. Sources: Investment Company Association of the Philippines, Private Sector Operations Department records, ATR KimEng Asset Management, Inc. 1999 2001 2003 2005 2007 2009

51. MFCP sales suffered particularly from a lack of effective distribution channels. Banks were not committed to providing referrals, as they offered competing products (Appendix 1), and regulations prohibited them from selling mutual funds directly to their customers and receiving a commission on these sales. At the same time, MFCP was unsuccessful in selling to members of pension funds, and had to close two of three retail money centers it had opened due to poor sales and high overhead costs. 52. The decline in MFCP’s net assets caused by low sales, high redemptions, and poor investment performance forced MFMCP to gradually shed key professional staff, as its management fee income had declined along with the fund’s capital base. This downsizing further affected fund performance. By the end of 2002, MFCP’s net asset value per share had slid to P0.48, net income amounted to a loss of P51.2 million, and net assets had fallen to P226 million. 53. By 2003, there was only one person managing MFCP’s portfolio, and only about 9 staff were allocated to research, sales and marketing, reporting and administration, including backoffice functions. MFMCP’s capital had fallen below the required minimum for a fund management company, and its shareholders were not willing or able to invest more. MFMCP’s performance was unsatisfactory.

11

In 1997, for example, MFCP sold about P105 million in shares, but redeemed P8 million, thus the net sales amount shown in the figure is P97 million.

11

c.

ATRKE Performance

54. In August of 2003, ATRKE infused P10.3 million into MFMCP to gain 70% ownership of the company. It would ultimately increase its stake to 95% and change MFMCP’s name to ATR KimEng Asset Management, Inc., a subsidiary of ATR KimEng Financial Corporation. ATRKE has been successful in improving the fund’s investment performance. In the past 7 years, MFCP has produced a net FIRR of 14.3% (Table 1), which ranks it third out of four funds that have been in operation that long. 55. ATRKE did not decrease the fund’s equity exposure fast enough to stave off high losses when markets declined as a result of the global financial crisis. Then, it did not reinvest in stocks soon enough to reap the most benefit from the recovery. ATRKE also maintains that its performance is not strictly comparable to that of other balanced funds, as these competitors sometimes maintain an equity exposure that is proportionally much higher or lower than investments in fixed income and other securities—disqualifying the fund as ―balanced‖. 56. From the retail perspective, MFCP has fared better under ATRKE, as the number of accounts increased (Appendix 3, Table A3.4), mostly through direct selling, seminars, and internet outreach. The portion of MFCP assets held by individuals relative to institutions has also increased, as has the total value of assets held in smaller-sized accounts. 57. ATRKE is also focused on keeping institutional investors satisfied. However, MFCP has recently suffered from high redemptions. In 3 of the past 4 years, redemptions have exceeded sales. In 2010, net redemptions were the highest in MFCP’s history, at P193 million. 58. ATRKE is very optimistic about the fund's near-term sales and investment prospects. Its foremost concern is the interest rate environment, as investors have little incentive to take on greater risk when government securities generate relatively high earnings. ATRKE’s performance has been partly satisfactory. d. Fund Performance

59. Over the past 10 years, MFCP’s annualized return has been in line with other balanced mutual funds in the Philippines (Table 1).12 In the first 7 years of its operation, however, the fund’s returns were poor relative to its peers, which brings its net FIRR since inception down to 3.47%, compared with 9.6% for the only competitor also operating since 1996, and 5.62% for the blended index.

12

Throughout the fund’s history, its fund managers have maintained that many of its competitors are not truly balanced funds, because at times their portfolios are composed largely of equities or bonds.

12

Table 1: Annualized Returns: Blended Index, MFCP, and Peers 1 Year 23.8% 42.3% 48.7% 47.3% 30.7% 62.0% 3 Year 5.9% 8.6% 10.9% 11.3% 5.9% 20.0% 5 Year 8.6% 14.4% 17.3% 19.2% 12.5% 26.9% 7 Year 9.6% 14.3% 17.0% 18.1% 13.0% 10 Year 8.3% 10.8% 14.5% 10.6% 10.3% Since MFMCP ATRKE 1996 Period Period 5.6% 3.5% (6.1%) 13.5% 9.6%

Blended Index MFCP Kabuhayan Fund Philam Fund GSIS Kinabukasan Fund Sun Life Prosperity Balanced Fund First Metro Save & Learn Balanced Fund

ATRKE =ATR KimEng Asset Management, Inc., MFCP = Mutual Fund Company of the Philippines. Source: Private Sector Operations Department records, Investment Company Association of the Philippines, Bureau of Treasury, Bangko Sentral ng Pilipinas.

60. As Table 1 indicates, MFCP's performance varies greatly before and after ATRKE took control of the fund management company. The net FIRR for the period before ATRKE’s control is –6.1%, compared with positive 13.5% thereafter. 61. Reflecting the generally positive economic trends, MFCP has averaged 17% growth each year from 2004 to 2010, earning negative returns only in 2008 (Figure 4). As per the Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations (footnote 4) the business success of MFCP has been measured by computing the return on invested capital (ROIC), which is used as a proxy for the FIRR. The real ROICis –2.27% and the nominal ROIC is 3.22%. As MFCP’s ROIC is more than 200 basis points lower than the compound annual growth rate of the blended index (5.62%, as per Table 1), the business success of ADB’s investment in MFCP is unsatisfactory.13 62. Figure 4 indicates the performance of MFCP’s net assets per share over time.

13

As the compound annual growth rate for the blended index is in nominal terms, MFCP’s nominal ROIC is used to assess business success.

13

Figure 4: Net Asset Value Per Share
1.63 1.31 1.18 1.04 0.79 0.60 0.75 0.67 0.55 0.48 0.66 0.75 0.86 0.93 1.14

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: Investment Company Association of the Philippines.

4.

Economic Sustainability

63. The economic rate of return on ADB's investment in MFCP is calculated as per ADB guidelines (footnote 4). Accordingly, the economic return on invested capital (EROIC) is used as a proxy for the economic internal rate of return (EIRR) because equity funding for this project was not targeted at specific capital investment projects. 64. EROIC is calculated by using the financial rate of return on MFCP’s capital and adjusting for fees and taxes paid. The real EROIC for the ADB equity investment in MFCP computes to a value of 0.26%. According to ADB guidelines, an EROIC lower than or equal to 5% is unsatisfactory, thus the contribution to economic development of the project is rated unsatisfactory. 65. However, there are additional economic benefits to ADB’s investment in MFCP that cannot be precisely measured or directly attributed to the investment. These benefits include the value created in output and employment by the dozens of companies in which MFCP has invested over the past 15 years. Given that ADB’s participation may have prevented the dissolution of MFCP and enabled ATRKE’s takeover of the fund management, the investment also played a part in the development of ATRKE’s additional mutual funds, which have P1.3 billion invested mostly in Philippine stocks and bonds. 66. At the same time, both MFCP fund managers have actively pursued efforts to improve the regulatory framework for mutualized investments and the standards that apply both to the mutual fund industry and to listed companies in the Philippines. Since there were so few funds active in the late 1990s, it is possible that MFCP’s voice helped tip the scales in favor of important changes—including the enactment of the CTRP and BSP’s decision to allow mutual fund managers to oversee more than one fund—and that ADB’s backing lent credibility to those efforts. These effects cannot be meaningfully measured, but they are certainly positive, and the long and steep growth path of the mutual fund industry attests to their sustainability.

2010

14

5.

Environmental, Social, Health, and Safety Performance

67. The subscription agreement signed between ADB and MFCP on 15 April 1996 requires the fund manager to review an investee’s level of compliance with environmental laws, regulations, and standards—including those relating to environmental impact assessments and involuntary resettlement—before it purchases any security for the first time or when making subsequent purchases. The MFCP investment did not have any additional socially oriented objectives other than attracting the country's mostly small-scale savers. 68. MFMCP and ATRKE have complied with the requirement to review an investee’s compliance with environmental laws, regulations, and standards by periodically obtaining a list of environmental clearance certificates (ECCs) provided by the Environmental Management Bureau, and making sure that an ECC has not been denied to any company in which the fund has an equity position. 69. This approach, combined with normal due diligence practices, has proved a satisfactory means of fulfilling ADB’s environmental standards as they existed at the time the investment was made, thus the MFCP investment is rated satisfactory regarding environmental, social, health, and safety performance. The cost and benefits of undertaking a detailed, in-depth review of an investee’s performance in these matters every time a security is purchased would not prove worth the effort, as individual mutual funds have no say in an investee’s governance, and no means to recover the additional costs of such reviews and stay competitive in their fee structures. D. ADB Investment Profitability

70. In April 1996, when ADB approved the purchase of 100,000,000 shares in MFCP, the net asset value per share was P1.00, so the value of ADB’s investment was P100 million (equivalent to $3.85 million at the time). As of 31 December 2010, MFCP’s net asset value per share had increased to 1.6276, and ADB’s number of shares had grown to 103,186,867, as dividends issued by MFCP in 2009 were converted into additional shares. The value of ADB’s investment, therefore, was P168 million ($3.83 million equivalent), which generates an FIRR of –2.13% in real pesos and –0.04% in dollars. 71. These returns compare with an expected net FIRR of 23% in dollar terms in the RRP. According to ADB's guidelines (footnote 14), because MFCP’s net FIRR is less than 0.7 times the expected rate of return established at approval, the project is rated unsatisfactory regarding ADB investment profitability. 72. However, compared with a composite index of equities on the PSE, which earned a net FIRR (in current pesos) of 3.26% in 1996–2010 (Appendix 3, Table A3.3), ADB’s investment in MFCP earned almost 50 basis points more, with a net FIRR in current pesos of 3.77%. E. ADB Work Quality

73. ADB's work quality is rated satisfactory. Though the rationale for the project and its initial design suffered from overly optimistic assumptions, the operation was a rather unique attempt on the part of ADB to intervene proactively in a severely underdeveloped and key part of the financial system. ADB staff took an active and watchful interest in the project over the greater part of its long life, and the investment has produced some important results and lessons, as well as other benefits (para. 65).

15

a.

Screening Appraisal and Structuring

74. The rationale for the investment is based on the idea that the mutual fund industry would benefit from the injection of capital from a highly credible institutional investor like ADB. While the RRP emphasizes that serious tax and regulatory disadvantages were restricting industry development, it does not attempt to weigh the effects of these problems against the perceived need for catalytic effects. The tax and regulatory disadvantages were determining factors for new entrants into the mutual fund market. 75. The project’s RRP places emphasis on the fund's expected benefits to small savers, but never explains how it defines these beneficiaries, nor does it set any targets against which to measure the investment's success. 76. Regarding the initial design, the RRP also overestimates the potential returns of the investment. While the RRP notes important performance risks—including poor performance of investee companies brought on by an unfavorable regulatory environment or political and economic turbulence, as well as the risk of currency fluctuations that could negatively affect the value of peso-denominated assets—there is no robust analysis of these risks. In the case of currency depreciation, for example, the RRP simply cites improving economic conditions and recent exchange rate stability as reasons to judge the level of risk as acceptable. Though it may not have changed the decision to invest in MFCP, an analysis of the fund’s performance under best, worst, and base-case economic scenarios would have provided a better basis for risk assessment. Thus, screening, appraisal, and structuring are rated partly satisfactory. b. Monitoring and Supervision

77. After the investment had been made, ADB was very engaged in oversight—attending board meetings and keeping close track of the fund and the fund manager. Project records show frequent communication between the fund and ADB staff. However, as the investment aged, ADB may have lost some rigor with respect to fund governance. Board meeting participation and other means of fund supervision become less traceable in the project files around 2001–2002. Monitoring and supervision is rated satisfactory. c. ADB Role and Contribution

78. In 2003, however, ADB participation in board meetings was crucial for convening a quorum to approve ATRKE’s takeover of the fund manager, and then to authorize important changes to fund policy and practice. 79. ADB’s long investment in MFCP has contributed to the fund’s survival, and prevented a more serious industry free-fall in 1997. ADB also reportedly encouraged MFCP to develop the comprehensive operations manual that was used by the SEC to assist other companies in the process of setting up mutual funds; to fully disclose risks to potential investors in the prospectus; and to adopt a code of ethics. ADB's role and contribution are thus rated satisfactory. d. Overall ADB Work Quality

80. As discussed above, screening, appraisal, and structuring of this operation are rated partly satisfactory; monitoring and supervision are rated satisfactory; and ADB's role and contribution are rated satisfactory. Overall work quality is rated satisfactory.

16

F.

ADB Additionality

81. ADB’s investment played an important role in getting MFCP off the ground in 1996, though it is impossible to know what would have happened otherwise. Six other institutional investors had committed capital before ADB signed its subscription agreement (Table 2). Table 2: Institutional Investors and Ownership Shares at Fund Inception Shareholder ADB Armed Forces of the Philippines Retirement and Separation Benefits System Pag-Ibig (Home Development Mutual Fund) Philippine Long Distance Telephone Co. Beneficial Trust San Miguel Corporation Retirement Fund Meralco Pension Fund PNB Provident Fund
ADB = Asian Development Bank, PNB = Philippine National Bank. Source: Private Sector Operations Department records.

% Ownership April 1996 18.9% 18.9% 18.9% 18.9% 18.9% 3.8% 1.9%

82. ADB was one of the largest and most respected of MFCP’s founding shareholders, and its participation may have been key, in early 1997, to attracting other international investors. When ATRKE took over the fund management, it took advantage of its parent company’s presence in Hong Kong to target overseas workers from the Philippines as well as local institutions. Having ADB as a shareholder in the fund was meaningful to these investors, who generally recognized and trusted the name. ADB is therefore likely to have contributed at these junctures. Overall, however, MFCP has not been able to leverage ADB’s participation to grow its net assets (Figure 2). The bank’s ownership has hovered around 20%–22% since 1998, and jumped up to nearly 34% at the end of 2010 due to large fund redemptions (Table 3). ADB’s additionality is rated satisfactory. Table 3: Value of ADB Shares in the Fund as a Percentage of Net Assets End of Year 2000 2003 21.8% 21.4%

1996 ADB's Ownership Percentage in MFCP 18.3%

2010 33.6%

ADB = Asian Development Bank, MFCP = Mutual Fund Company of the Philippines Source: Private Sector Operations Department records, ATR KimEng Asset Management, Inc.

G.

Overall Evaluation Table 4: Performance of the Investment in the Fund Unsatisfactory Partly satisfactory X X Satisfactory Excellent

Development Impact Private sector development Business success

X

17

Unsatisfactory Contribution to economic development Environmental, social, health, and safety performance ADB Investment Profitability ADB Work Quality Screening, appraisal, and structuring Monitoring and supervision ADB role and contribution ADB Additionality X

Partly satisfactory

Satisfactory

Excellent

X

X X X

X X X Unsuccessful Partly successful X Successful Highly successful

Overall Assessment Source: Independent Evaluation Mission. III. A.

ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS

Issues and Lessons

83. ADB’s investment in MFCP was intended to catalyze the mutual fund industry in the Philippines, but industry growth proved to be constrained by tax and regulatory rules that put mutual funds at a disadvantage versus other mutualized products. This became evident when double taxation was eliminated in 2000 and the industry began to take off, and when unit investment trust funds (UITFs) were forced to adopt marked-to-market valuation in 2004 and began to lose substantial ground to mutual funds (Appendix 1). While there may be cases where demonstration effects and increased market confidence stemming from an ADB investment could help foster market development, the bank must have stronger reasons and analytical support for such an approach. 84. In some cases, leading a policy dialogue or financing technical assistance to support the development of a better enabling environment or build regulatory capacity, for instance, may be more effective alternatives to an equity investment. In July of 1995, for example, ADB hosted a seminar on mutual fund industry regulation that is recognized now as the point of departure for the modern mutual fund industry’s growth and development. ADB also assisted the government in preparing a more appropriate Securities Regulation Code, enacted in 2001, and in reorganizing the SEC according to the new framework when the BW Resources scandal hit the PSE in 2000, exposing serious weaknesses in the SEC and its enabling legislation.14 ADB’s

14

ADB. 1995. Technical Assistance to the Republic of the Philippines for the The Capital Market Development (TA 2379). Manila. ADB. 2001. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the Republic of the Philippines for the Nonbank Financial Governance Program (Loan 1858). Manila.

18

credibility, expertise, and resources can thus be brought to bear on industry development in different ways. 85. Competition between UITFs and mutual funds still suffers from unequal regulatory treatment. UITFs are contracts, regulated by BSP as banking products, whereas mutual funds are overseen by the SEC and treated as corporations. They have very different costs and benefits that are opaque and very difficult for offering companies and for investors to disentangle (Appendix 1). A lack of financial understanding is perceived as a key constraint to the growth and widespread consumer uptake of mutual funds. Personal investment is still a new concept in the Philippines and consumers know little about the safety, liquidity, and potential returns of different investment options. 86. Adding to the confusion, there are many other types of mutualized investment products besides mutual funds and UITFs, including variable unit-linked insurance products, pre-need products, and insurance annuity contracts, each with different regulatory and tax treatment. For more than 15 years members of the industry have been working with government to develop harmonized regulations for these products. The most recent efforts are manifest in the proposed CIS law, which incorporates and expands the reforms previously proposed in the Revised Investment Company Act. 87. Regulatory harmonization is particularly critical now because, in 2008, Congress passed the Personal Equity and Retirement Account Act, which allows Philippine citizens to create individual retirement accounts and receive limited tax credits. The act has no implementing rules yet, so there is only speculation about how it could affect incentives to sell or hold one type of investment over the other. The law has the potential to greatly expand the universe of personal investors and the pool of investment capital, but also to add confusion to the market along with more opportunities for regulatory arbitrage. 88. Under the best-case scenario, the CIS law would transfer regulatory responsibility for all mutualized investment products to the SEC, which is already seriously understaffed. For the past 10 years, only one person has been dedicated to monitoring mutual funds, while net mutual fund assets have increased by a factor of nearly 40. If the SEC gains responsibility for overseeing all mutualized investments, it will require a much larger program of support. There is substantial need to build capacity and educate the SEC about international norms and best practices, and to provide support for organizational restructuring and staffing plans. 89. It is crucial for investors to have access to systems that allow them to easily administer regular cash payments to mutual funds from employer payrolls or bank accounts. Such access is extremely limited in the Philippines, and in most cases face-to-face visits are needed to handle payments or redemptions. 90. At present, the small number of listed companies on the PSE and the lack of liquidity in their shares are not an important constraint on the growth of mutual funds, as there are still relatively few investors in the market. However, given the recent pace of mutual fund growth, it could become an issue in the future. B. Recommended Follow-up Actions

91. The following actions are recommended to follow up on the goals and achievements of the MFCP investment:

19

(i)

(ii)

ADB’s exit from MFCP should be gradual. ADB controls a large share of the fund’s net assets (34%). Abrupt divestment would cause a precipitous drop in ATRKE’s fee income, which could hurt its ability to manage the fund. It could also alarm other investors and trigger a wave of fund redemptions. Any future ADB policy analysis and dialogue on capital market development in the Philippines could include issues relevant to the development of the mutual fund industry.

20

Appendix 1

MUTUAL FUND INDUSTRY DEVELOPMENTS A. Market Size and Evolution

1. Mutual fund industry development in the Philippines has been characterized by spectacular growth over the past 15 years (Figure A1.1). Figure A1.1: Mutual Fund Assets Under Management in the Philippines (P billion)
120.0 100.0 80.0 60.0 40.0 20.0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Source: Investment Company Association of the Philippines.

2. The number of mutual funds has increased from six in 1996 to approximately 45, and investor accounts have grown from approximately 2,800 in 1998 to 106,000 in 2010. In the 1990s, the industry was starting from close to zero, and it remains small relative to many countries in the region and to its economic peer group (Figures A1.2 and A1.3). Figure A1.2: Net Mutual Fund Assets (% of GDP)
0.6 0.5 0.4 0.3 0.2 0.1 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Philippines Korea Japan China India Pakistan

Source: Investment Company Institute, Private Sector Operations Department records, mutual fund industry associations, regulators, and central banks.

Appendix 1

21

Figure A1.3: Net Mutual Fund Assets (% of stock-market capitalization)
0.7

0.6

0.5

0.4

0.3

0.2

0.1

0 1998
Philippines

1999

2000

Korea

2001

2002

Japan

2003

2004

China

2005

2006

India

2007

2008

Pakistan

2009

Source: Investment Company Institute, Private Sector Operations Department records, mutual fund industry associations, regulators, and central banks.

B.

Competition and the Regulatory Framework 1. Mutual Funds and Unit Investment Trust Funds

3. Though there are other important factors, the key to realizing the industry’s growth potential lies in the development of an equitable regulatory environment for all mutualized investment schemes. The lack of fair competition between similar products has stymied Philippine mutual fund industry development for decades, starting in the 1970s. At that time, banks invented a product called common trust fund (CTF) that was essentially a money market fund invested mainly in fixed-income securities. CTFs were attractive because they carried no reserve requirements, and many banks used them as pseudo deposits. By 1993, when the Central Bank of the Philippines (BSP) first instituted reserve requirements for CTFs (though at a lower rate than deposits), assets invested in these instruments had grown to P112 billion 1 compared with just P750 million in mutual funds.2

1

2

ADB. 1996. Report and Recommendation of the President to the Board of Directors: Proposed Equity Investment in the Mutual Fund Company of the Philippines. Manila. Investment Company Association of the Philippines.

22

Appendix 1

4. BSP began a gradual phase-out of CTFs, replacing them with a very similar instrument, the unit investment trust fund (UITF). UITFs had reserve requirements on a par with deposits, but with two great advantages over mutual funds: (i) they did not face double taxation (mutual funds had to pay corporate income tax and investors were also subject to taxes on their capital gains); and (ii) UITFs were not valued on a marked-to-market basis. 5. In 1998, the Comprehensive Tax Reform Program (CTRP) eliminated the double taxation of mutual funds, and opened the door to a period of rapid growth. Still, the valuation method for UITFs made them much more advantageous than mutual funds and by 2004, CTFs and UITFs held about $620 billion in assets under management, whereas mutual funds held only $54 billion.3 6. When BSP issued a rule requiring UITFs to adopt marked-to-market valuation in 2004 and finalized the phase-out of CTFs, competition between trusts and mutual funds became a more even contest, though it is still far from equitable. The main difference between these very similar offerings is that UITFs are contracts, regulated by BSP as banking products, whereas mutual funds are overseen by the Securities and Exchange Commission (SEC) of the Philippines and treated as corporations. 7. Every mutual fund must have the minimum required seed capital and pay registration fees to the regulator, and it reportedly takes a year to obtain a license. As corporations, each mutual fund must cover the costs associated with having a board of directors, producing annual reports, and convening shareholder meetings. Mutual funds must also pay a documentary stamp tax on shares reissued after redemption. UITFs, on the other hand, require no preapproval or seed capital, net assets are simply included when calculating the fee that banks pay BSP for supervision, and they incur no stamp tax. 8. Mutual funds have some advantages over UITFs, however. For instance, they hold taxes at the corporate level, whereas many UITFs have a final 20% withholding tax at source. The issuer of a bond pays that tax but passes it on to the UITF. A mutual fund also has to pay this bond tax, but on its books the 20% is more than its expenses (i.e., it has negative income), thus no tax is withheld. Mutual funds can also have an incentive structure with a carry, and can create funds of funds and invest overseas. Nonetheless, UITFs have an important advantage in the treatment of tax-exempt organizations, which are potentially the largest purchasers of mutual funds. 9. These are only some of the regulatory and tax differences between mutual funds and UITFs, the result of which is that companies and customers have to disentangle the complex web of advantages and disadvantages of very similar products before they decide what to offer and purchase. The outcome of this weighing of options, it turns out, depends on the economic environment. If interest rates are high, mutual funds are better for investors because not all mutual fund assets are valued at marked-to-market. If interest rates are low, UITFs are more advantageous to investors. 2. Other Competing Products

10. Philippine investors looking to place their savings have other options besides mutual funds and UITFs. In 2007, BSP introduced special deposit accounts (SDAs) issued for 30, 60, 90, 120, and 180 days, and allowed banks to retail these products, which paid 3% more than T3

Mission interviews.

Appendix 1

23

bills and carried no reserve requirements. As a risk-free alternative to mutual funds, SDAs presented a serious competitive threat before BSP limited them to 14-day and 30-day tenures in 2008. 11. More similar to mutual funds are variable unit-linked insurance products, pre-need products, and insurance annuity contracts. The Insurance Commission regulates providers of these products. Very little data is available on the amount invested in the variable unit-linked, pre-need, and annuity products, and industry observers voice concerns about the adequacy of the reserves that back these contracts. 12. Adding complexity to the market for mutualized investment products, in 2008 Congress passed the Personal Equity and Retirement Account Act, which allows Philippine citizens to create individual retirement accounts and receive a 5% tax credit for contributions up to P100,000 for individuals and P200,000 for families. The act has no implementing rules yet, so there is only speculation about how it could affect incentives to sell or hold one type of investment over the other. The law has the potential to greatly expand the universe of personal investors and the pool of investment capital, but also to add confusion to the market along with more opportunities for regulatory arbitrage. C. Market Development Priorities 1. Harmonizing the Regulatory Treatment

13. For more than 15 years members of the industry have been working with government to develop new regulations for mutualized investment products. The most recent efforts are manifest in the proposed collective investment scheme (CIS) law, which incorporates and expands the reforms previously proposed in the Revised Investment Company Act. The CIS law aims to harmonize regulations for all forms of mutualized investments across the board. 14. A technical working group was formed in 2007 to promulgate the new law, and it recommended that mutual funds, UITFs, variable unit-linked insurance, pre-need products, and insurance annuity contracts be sold and regulated via a corporate structure in which investors buy shares, rather than simply sign contracts to purchase units. The SEC would regulate these products and the companies offering them. While there is much consensus around the CIS proposal, domestic banks are reportedly resisting the changes. BSP and the Insurance Commission are also reticent about giving up regulatory control over the products they now oversee. 2. Building Regulatory Capacity

15. There have been very few new rulings from the SEC on mutual funds in the past 5 years, as the regulator struggles to keep up with an industry that has grown by more than 25% in that time. The SEC is too understaffed to manage the increased workload—for the past 10 years, only one person has been dedicated to monitoring mutual funds. The SEC has said that it needs help both in developing new regulations for mutual funds and in building its capacity to regulate. If the SEC gains responsibility for overseeing all mutualized investments, it will require a much larger program of support.

24

Appendix 1

D.

Industry Prospects and Needs

16. The mutual fund industry in the Philippines is still at an early stage of development. As long as government debt is not generating equity-like returns, and no additional regulatory distortions are put in place, mutual funds will be a competitive option for longer-term investors. The Personal Equity and Retirement Account Act could significantly accelerate the industry's growth, if the act is regulated properly. 17. In addition to fair and sound regulations, the mutual fund industry principally needs educated investors and the infrastructure to reach them efficiently. Personal investment is still a new concept in the Philippines and consumers know little about the safety, liquidity, and potential returns of different investment options. Many industry participants agree that a lack of financial understanding seriously limits growth and consumer uptake of mutual funds. 18. At the same time, efficiently administering share sales requires systems that allow customers to easily set up regular cash payments from their employers or their bank accounts. Such ease does not exist in the Philippines, and in most cases face-to-face visits are needed to handle payments. The infrastructure to electronically administer payments is crucial for mutual funds, as they do not have the extensive branch or agent networks on which banks and insurance companies rely for customer contact. 19. At present, the small number of listed companies on the Philippine Stock Exchange and the lack of liquidity in their shares are not an important constraint on the growth of mutual funds, as there are still relatively few investors in the market (Appendix 4). Given the recent pace of mutual fund growth, however, it will become a problem in the near future.

Appendix 2

25

PRIVATE SECTOR DEVELOPMENT INDICATORS AND RATINGS Indicators 1. Wider Sector and Economy Impact Beyond Intermediaries and Investees 1.1 Private sector expansion and institutional impact: 1.1.1 Contribution by the fund to pioneering or materially increasing the private sector's share and role in the economy. 1.1.2 Institutional development contribution by: (i) improving supply of risk capital in the market; (ii) demonstrating the merits of private mutual funds to the public, firms, banks, and others; (iii) bringing liquidity to local stock exchanges; (iv) helping a mutual fund industry take root and become more efficient along with maturing capital markets; and (v) enabling wider mutual fund expertise via migration of fund manager staff to other funds, etc. Ratings a Justifications/Annotations

Partly satisfactory

The mutual fund industry grew sharply since MFCP initiated operations, but the fund contributed very little to that growth, as its net assets actually declined over the 1996– 2010 period. However, ATRKE has leveraged its infrastructure and know-how to open four additional mutual funds in the Philippines, with a total of P1.3 billion in mutual fund assets under management (compared with an industry total of P95.7 billion). Likewise, the number of mutual fund accounts has grown significantly but MFCP has had poor retail performance and little impact on the increased number of investors. MFCP had only 2800 accounts in 2010, while the industry has grown to more than 106,000 accounts, which is still a very small number given the population of the Philippines (estimated at more than 94 million for 2010). The capital markets have shown some positive signs of growth since MFCP began its operations, but little of the progress, or lack of it, can be attributed to the fund. Domestic savings have increased dramatically but those funds are not largely invested in mutual funds or directly in the stock and bond markets. The market capitalization of the Philippine Stock Exchange as a

26

Appendix 2

Indicators

Ratings a

Justifications/Annotations share of gross domestic product has trended downward in the past 15 years, the number of listed companies has grown from about 210 to just 250, and the volume of shares traded as a percentage of total shares listed was slightly lower in 2009 than in 1995. The Philippine bond market has grown steadily since 2000. Prospects for continued growth are good, especially for corporate issues, which have increased as a portion of total bonds outstanding since the Philippine Dealing and Exchange Corporation was opened as a secondary market for government and private debt securities in 2005. Except for its early years, MFCP has been a small, not very competitive player in the mutual fund market. For the past 10 years, however, the fund’s annualized returns have been competitive with other balanced funds. ATRKE’s management information system (Bloomberg’s AIM) and robust investment analysis tools created a new standard against which other funds compete. Employees who train in the use of these tools become assets for other mutual fund management companies, given the valuable knowledge and practical skills from their employment at ATRKE. In 1996, MFCP was one of only seven mutual funds, with only one other fund entering the market in 1997. MFCP’s net assets accounted for nearly one-quarter of the industry total

1.2 Competition: Contributions to renewed competitive pressures in key investee markets and/or in the financial sector for risk capital and finance.

Partly satisfactory

1.3 Innovation: Indications that the fund helped introduce effective new products, services, and new technologies, as well as replicable new business strategies in investee companies, or in the way the fund operates, thereby supporting reform and transformation of business sectors, industries and/or maturing financial markets (see 2.2 below).

Satisfactory

1.4 Catalytic element: Pioneering or catalytic finance that mobilized, or will contribute to, wider and better debt or risk capital supply from local and foreign investors to investees and to local financial sectors generally.

Partly satisfactory

Appendix 2

27

Indicators

Ratings a

Justifications/Annotations for both those years. Thus it was a pioneer in the industry and, as a big fund at that time, MFCP contributed some degree of stability to the industry during the Asian financial crisis. The catalytic or demonstration effects of the fund were limited, however, because industry growth was constrained by an unequal tax and regulatory treatment, and because fund performance was poor. MFCP fund managers successfully joined forces with other members of the Investment Company Association of the Philippines to finally persuade government to pass the Comprehensive Tax Reform Program, which eliminated the double taxation of mutual fund profits and opened the door to a period of very fast growth. They also secured the right for fund managers to manage more than one mutual fund, which made mutual fund management a much more viable business. However, despite years of efforts to harmonize regulation, huge obstacles to fair competition remain, as very different rules apply to similar mutual investment products. ATRKE incorporates the evaluation of an investee’s environmental, social, and governance performance, which is a unique practice in the industry.

1.5 Affected laws, frameworks, regulation: Contribution to better legal and regulatory private sector frameworks, or to better financial sector regulation, e.g., by observed lobbying activity. The fund manager reports on significant dialogue affecting reform.

Partly Satisfactory

1.6 Wider demonstration of new standards: Complies with good standards, and has set replicable new standards in, among others, corporate governance; transparency; stakeholder relations; environmental, social, health, and safety performance; and energy conservation. Demonstrated governance standards and improved transparency. (See 2.2 below) 2. Investee-Level Impact 2.1 Skills with demonstration and

Satisfactory

Not Applicable

As a mutual fund, MFCP could

28

Appendix 2

Indicators wider dissemination potential: - Manifest achievements in new strategic and operational management skills contributed to successful investee enterprises with potential for more widespread demonstration and replication. - Achievements in developing skills in mutual fund management, instruments, and new ways to invest that the fund staff can apply in follow-on funds, or when joining new mutual funds, banks or other financing. 2.2 Demonstration and new standardsetting potential: - As seen in new ways of operating businesses and competing, and where investee performance is comparable with relevant best industry benchmarks and standards - As evident in set standards in corporate governance and stakeholder relations

Ratings a

Justifications/Annotations not own more than 10% of the issues or any given investee company, and frequently changed its positions. MFCP thus did not have a direct operational impact on the companies in which it invested.

Satisfactory

MFCP is credited with having developed a fully documented operations manual at its outset that was used by the Securities and Exchange Commission of the Philippines to assist other companies in setting up mutual funds. Likewise, project documentation indicates that the MFCP’s prospectus was exemplary for its full disclosure of relevant information to prospective investors. MFCP reportedly led the industry by publishing its results in the newspapers based on longerterm returns and not just daily returns, and by adherence to a code of ethics. ATRKE is working with the Fund Managers Association of the Philippines to implement stronger corporate governance requirements within investee companies.

Overall Private Sector Development Rating

Partly satisfactory

ATRKE = ATR KimEng Asset Management, Inc.; MFCP = Mutual Fund Company of the Philippines. a Ratings scale: Unsatisfactory, Partly Satisfactory, Satisfactory, and Excellent. The rating is not an arithmetic mean of the individual indicator ratings, and these have no fixed weights. It considers actual impact (positive or negative) and potential further impact as well as risk to its realization.

Appendix 3

29

REVIEW OF THE FUND A. Fund Management and Governance

1. The Mutual Fund Company of the Philippines, commonly known as the Kabuhayan Fund, was incorporated in December 1995 as an open-end mutual fund with the investment objectives of preserving shareholders’ principal, generating current income, and promoting long-term capital growth. MFCP invests in a balanced portfolio of listed and non-listed equities and fixedincome securities issued by Philippine companies, money market instruments, and government debt obligations. MFCP requires a P5,000 minimum initial share purchase, which is offered primarily to Filipinos. 2. MFCP is now managed by ATR KimEng Asset Management, Inc. (ATRKE). ATRKE earns management and distribution fees equal to 2% of MFCP’s net assets, plus 0.15% for fund administration. ATRKE is a subsidiary of ATR KimEng Financial Corporation, which is majorityowned by the ATR KimEng Group, a family of global financial services companies with deep roots in Asia. ATRKE manages five mutual funds, including MFCP, with a total of P1.27 billion in assets under management. 3. For about the first 7 years of its operational history, MFCP contracted the Mutual Fund Management Company of the Philippines (MFMCP) to manage, distribute, and administer the fund. MFMCP was established in 1995 solely to manage MFCP, principally under the ownership of Clemente Fund Management Asia (CFMA)—owned by Clemente Capital, which was based in New York—and the Philippine National Bank (PNB). 1 ATRKE took a controlling ownership position in MFMCP in August 2003, and eventually changed the company name to its own.2 4. MFCP’s board of directors is composed of eight members—representatives of the PLDT Beneficial Trust, ATR KimEng Group, Meralco Pension Fund, and PNB Regular Retirement Fund, as well as two attorneys from the law firm that provides external legal counsel to MFCP, and two independent directors. 5. MFCP’s code of corporate governance outlines standard control procedures both for internal and external compliance, and safeguarding MFCP’s assets. Qualified outside agencies perform the roles of custodian bank, transfer agent, fund accountant, and external auditor. MFCP has an internal code of ethics, which prohibits directors, officers, general partners, portfolio managers, advisors, and investment personnel from engaging in personal trading in securities for which they have beneficial ownership. MFCP is in full compliance with all rules of the Securities and Exchange Commission (SEC) of the Philippines that pertain to its business. As required by the SEC, MFCP is not allowed to invest more than 10% of its net assets in any single company. Mutual funds are also prevented by regulation from owning more than a 10% share in any one company. B. Fund Performance in Market Context

6. Over the past 10 years, MFCP’s annualized return has been average compared with other balanced mutual funds in the Philippines (Table A3.2).3 In the first 7 years of its operation,
1

2 3

CFMA and PNB initially owned 35% each of MFMCP, and the National Investment Trust of Taiwan and Daiwa Asset Management of Japan owned the remainder of shares in equal proportion. A subsidiary of ATR KimEng Group owns 95% of ATRKE, and CFMA owns the remaining shares. Throughout the fund’s history, its fund managers have maintained that many of its competitors are not truly balanced funds, because at times their portfolios are composed largely of equities or bonds.

30

Appendix 3

however, the fund’s returns were very poor relative to peers, which brings its net financial internal rate of return (FIRR) since inception down to 3.5%, compared with 9.6% for the only competitor also operating since 1996 (Table 1). 7. As Table 1 in the main text indicates, MFCP's performance varies greatly before and after ATRKE took control of the fund management company. The net FIRR for the period before ATRKE’s control is –6.1%, compared with 13.5% thereafter. 8. The different economic conditions that prevailed in these two periods explain some of the difference in fund performance. When the Asian financial crisis struck Philippine markets in mid-1997, the dollar–peso exchange rate shot up 52% in just 6 months. Yields on 91-day T-bills nearly doubled between March and December, reaching a high of 18.1%, while the stock market index dropped by 41%. Both the blended index (–31%) and the Phisix (–41%) were down in 1997, as were most blended funds (Table A3.2). 9. MFCP also produced negative returns, but performed slightly better than the blended index in 1997. It performed relatively very poorly, however, before and after the crisis. 10. After a brief rebound in 1999, Philippine markets again contracted sharply in 2000–2001 due to serious revelations of fraud, high levels of political instability, growing macroeconomic imbalances, and global events—including the bursting of the tech-stock bubble and the 9/11 terrorist attacks in the United States in 2001. 11. Among the worst of the scandals to affect Philippine markets was the BW Resources price manipulation scandal in 2000, during which the entire compliance and surveillance team of the Philippine Stock Exchange (PSE) resigned after the board ignored its recommendation to investigate certain brokers for fraudulent trading activities. The exchange was temporarily stripped of its Self Regulating Organization license, hurting investor confidence in both PSE and the SEC, which had not been able to prevent or detect the fraud. Also in 2000, the Philippine House of Representatives sent articles of impeachment to the Senate, accusing then President Estrada of bribery and corruption. Meanwhile, interest rates rose sharply as the government missed its debt targets, gross domestic product (GDP) growth slowed to 1.8%, and the peso lost one-third of its value relative to the dollar. 12. In contrast to these earlier periods, the fund has benefited from a positive economic environment during most of the past 7 years. Real GDP growth in the Philippines averaged 5.1% over 2004–2010, the peso appreciated 20% relative to the dollar, average interest rates on government securities have declined from a high of 8% to less than 2%, and core inflation has hovered around an average of 5%. 13. These positive domestic trends began with the resolution of the value-added tax issue in 2003. The government was running a massive deficit at that time, had very little reserves, and was debating whether or not to implement such a tax. The Philippines was facing the risk of debt default and an economic meltdown without the tax. When the tax was enacted, it brought confidence (and investment) to the market. At about the same time, the country began to experience what would be a long boom in telecommunications, a sector that makes up 25% of the stock market index. 14. Worldwide economic conditions have also generally been favorable during 2004–2009, the global financial crisis notwithstanding. Worldwide growth averaged 2.5% over the period

Appendix 3

31

(before the upturn in 2010), while growth in East Asia and the Pacific region averaged a faster 3.3%. 15. Reflecting the generally positive economic trends, MFCP has returned positive results every year bar one since 2004, averaging 17% growth in net asset value per share up to 2010. Its performance has been competitive relative to peers and market benchmarks (Table A3.2 and Table A3.3). C. MFMCP Performance

16. MFMCP’s investment strategy was to invest in a balanced portfolio of equity securities of Philippine incorporated companies, fixed-income securities of Philippine companies, and government debt obligations. MFCP had a 10% limit for any one company in its portfolio and a limit of 10% of the outstanding share capital of any company. From 1996–2003, MFCP’s generally negative results compared with the market were, in large part, the product of poor investment decisions. Until the third-quarter of 1998, the chief investment officer at Clemente Capital headquarters in New York made all the investment decisions, which MFMCP personnel in Manila would execute. Given the volatile market conditions and the difference in time zones, trades that might have been profitable were often on the wrong side of market movements. Clemente Capital also expected the market to recover in 1998, earlier than it did, and stayed in or added to equity positions that were battered along with the rest of the market. 17. To rectify the investment performance problem, MFMCP authorized the Manila-based president of the company to make investment decisions on a day-to-day basis, and adjusted its investment portfolio. The number of stocks held in the portfolio was reduced by half, to about 12 issues, so the investment manager could do a better job of monitoring performance and controlling risk. 18. However, by the time these changes were made, the accumulation of investment losses had contributed to the erosion of MFCP’s capital base. The fund had P560 million in net assets at the end of 1996; by the end of 1998, it had little more than half that amount. 19. The decline in MFCP’s net assets was also due to the complete divestiture, in 1998, of two of MFCP’s founding shareholders—the retirement funds of the San Miguel Corporation and the Armed Forces of the Philippines. These institutions withdrew from the fund after they themselves came under financial strain from the Asian financial crisis. Together, these institutions held about 40% of MFCP’s subscribed shares. 20. Despite the poor performance, the MFCP board decided late in 1998 to extend MFMCP’s contract as fund manager, after seriously considering another company. The decision was affected by the changes MFMCP made to its investment decision-making process. MFCP did improve its performance in 1999, returning 18.2%, nearly 9% more than the blended index (Table A.3.3). 21. These relatively positive results did not continue, however. The fund was again beset by poor investment performance over 2000–2002, as well as disappointing net sales. For the most part, sales and redemptions cancelled each other out during 1999–2003, and the number of total accounts actually declined. 22. Sales and redemptions of MFCP shares were affected by MFCP’s poor investment performance, but also suffered from a lack of contact with customers. MFCP had initially

32

Appendix 3

planned to reach individual investors by leveraging the branch network and customer relationships of PNB, as well as the members of large pension funds, and through its own retail money centers, three of which were opened in 1996. 23. PNB branch managers were not committed to providing referrals, however, since regulations prohibited them from being paid a commission, and they were selling their own mutualized investment products: common trust funds (CTFs) and unit investment trust funds (UITFs). At the same time, MFCP was unsuccessful in selling to members of pension funds, and had to close two of its three money centers due to poor sales and high overhead costs. 24. The decline in MFCP’s net assets caused by low sales, high redemptions, and poor investment performance forced MFMCP to shed key professional staff, as its fee income had declined along with the fund’s capital base. By 2001, MFMCP was in financial stress, and its management introduced MAA International, an insurance company based in Malaysia, to the board of MFCP as a prospective investor in the fund manager. MAA was interested in buying 70% of MFMCP—a deal that the MFCP board approved in principle. However, the deal was never closed due to the decision of an MFMCP shareholder, PNB, to exercise its right of first refusal, saying it needed more time to study the proposal, at which point MAA walked away. 25. MFMCP’s problems (and the fund's performance) continued to worsen, and it was forced to downsize further, which likely contributed to even poorer results. The end of 2002 marked a low point in the history of MFCP. Net income amounted to a loss of P51.2 million, net assets declined to P26 million, and net asset value per share slid to P0.4833. By this time, only one person managed investments, and only about 9 staff were allocated to research, sales and marketing, and reporting and administration, including back-office functions. 26. In early 2003, MFMCP’s capital fell below the required minimum paid-up capital for a fund management company, and neither its controlling shareholder, CFMA, nor its parent Clemente Capital could provide it. However, CFMA and another MFMCP shareholder were able to buy out PNB, paving the way for a new entrant. D. ATRKE Performance

27. ATRKE was looking to broaden its range of products and felt that the time was right, in 2003, to move into mutual funds. In August of that year, ATRKE infused P10.3 Million into MFMCP to effectively gain 70% ownership of the company. Soon after, ATR KimEng Capital purchased an additional 13% from existing shareholders, increasing its stake in MFMCP to 83%. MFMCP would eventually change its name to ATR KimEng Asset Management, Inc. (ATRKE), as a subsidiary of ATR KimEng Financial Corporation. 28. ATRKE’s first step was to get the MFCP board reengaged in fund governance, as the board was having difficulty convening a quorum of directors for its quarterly meetings. ATRKE also doubled the number of issues in the portfolio, built a small sales force of 12 people, and opened two new branch offices, but it was most focused on building a good track record so that it could rebuild the MFCP brand and attract new investors. 29. ATRKE was successful in improving fund performance, returning 19% on average during 2004–2007, bolstered by favorable macroeconomic conditions. ATRKE has also benefited from a much more equitable regulatory environment, thanks to the BSP ruling in 2004 that requires UITFs to adopt marked-to-market valuation. Apart from MFCP, ATRKE also manages an equity opportunity fund, AsiaPlus recovery fund, a money market fund, and a total return bond fund.

Appendix 3

33

The equity opportunity fund, which has been in operation since November 2004, has outperformed its benchmark PSE index in it’s ―since inception returns.‖ 30. However, MFCP performed significantly worse than peers and market benchmarks in 2008, when markets were reeling from the effects of the global financial crisis. ATRKE did not cut its equity position fast enough that year, and in early 2009, it did not bet soon enough on the recovery. Overall, since it took control of MFCP, ATRKE reports that the fund’s risk-adjusted performance has been better than average. 31. ATRKE’s approach to the fixed-income market for its funds is return driven, i.e., seeking absolute performance rather than returns relative to benchmarks. Their fixed-income strategy is buy and hold—not to trade often but to employ a multi-year approach. ATRKE reports that MFCP has lately been pretty heavily invested in equities, generally between 55–60%. Debt securities have generally been less than 30% of the portfolio, comprising a couple of corporate issues and the rest government debt. 32. To reach more individual investors, ATRKE has launched four other mutual funds, which is an important element of their distribution strategy. In order to sell through banks, ATRKE must be able to offer a portfolio of investment products. By the first half of 2011, ATRKE was to have 4 banks and 1 securities dealer recommending its products, including MFCP. 33. For now, however, ATRKE says it is focused on keeping institutional investors satisfied. The fund has suffered from high redemptions, leading to negative net sales in 3 of the last 4 years. Two large institutional investors divested their MFCP shares in 2009 and 2010, leading to a 20% decline in MFCP’s net assets since 2007. MFCP thus ended 2010 with only P500 million in net assets. 34. However, ATRKE remains very positive about the fund’s near-term sales and investment prospects. Its foremost concern is the interest rate environment, as investors have little incentive to take on greater risk when government securities generate relatively high earnings.

34

Table A3.1: Annual Returns of Balanced Mutual Funds (%) Fund First Galleon Family Fund Philam Fund Citisec Growth & Income Fund MFCP Kabuhayan Fund GSIS Kinabukasan Fund ECC Growth & Income Fund All Asia Fund Sun Life Prosperity Balanced Fund Emergent Fund MAA Privilege Peso Fund Legacy HY Fund First Metro Save & Learn Balanced Fund Optima Balanced Fund ALFM Growth Fund Bahay Pari Solidaritas Fund NCM Mutual Fund of the Philippines 1996 6.3 19.1 17.8 2.9 1997 (39.5) (7.9) 1.7 1998 (1.0) 12.6 22.5 1999 2000 2001 2002 2003 2004 2005 2006 0.4 36.7 2007 2008 2009 2010

Appendix 3

2.7 14.0 (26.3) 2.4 18.2 (23.9)

(0.9)

4.3

24.2 36.0

17.6

14.9

0.2 19.4 (32.5)

35.9

48.7

(27.7) (10.9) 12.3

(8.5)

(12.0) (18.6) 23.7

14.4 17.2

14.2 13.5

38.0 43.0

10.6 (29.3) 21.9 (31.7)

27.5 37.0

42.3 47.3

30.3 (25.9) (14.6) 7.5 12.6

4.1

31.7

14.9 (25.2)

21.7

30.7

2.1 9.2 2.8 (6.9) (23.9) (26.0) 45.4 21.5 64.3 62.0 27.4 53.7 41.1 43.3

Source: Investment Company Association of the Philippines.

Table A3.2: Annual Returns, Mutual Fund Company of the Philippines vs. Benchmark Indices (%) Annualized Return 1996–2010 3.5 5.6

Fund MFCP Net Blended Index MFCP over/under performance Phisix MFCP over/under performance

1996

1997

1998

1999

2000

2001

2002

2003 36.0 27.6

2004 14.4 19.0

2005 14.2 12.2

2006 37.9 27.4

2007

2008

2009 27.5 38.7

2010 42.3 23.8

2.9 (27.7) (10.9) 17.5 (20.0) 8.6

18.2 (23.9) 9.6 (13.4)

(8.5) (12.0) (8.2) (3.7)

10.5 (29.3) 14.6 (25.7)

(14.6)

(7.7) (19.5) 5.33

8.6 (10.6)

(0.3)

(8.3)

8.4 41.6

(4.6) 26.4

2.0 14.9

10.6 42.4

(4.0)

(3.6) (11.2) 63.0

18.5 37.5

(2.1) 3.3

22.2 (41.0)

8.8 (30.3) (21.8) (12.8)

21.4 (48.3)

(19.3)

13.3 (16.2)

9.4

6.3

13.3

(0.8)

(5.6) (12.0)

(0.7)

(4.5)

(10.9)

19.0 (35.5)

4.7

.02

MFCP = Mutual Fund Company of the Philippines. Sources: Philippine Stock Exchange fact books and annual reports, Bureau of Treasury, Central Bank of the Philippines, Investment Company Association of the Philippines.

Appendix 3

35

36

Appendix 3

Table A3.3: Computation of Net Blended Index Year WAIR 5-yr Treasury Notes (Net)a % 11.7 10.2 14.2 11.4 11.0 11.6 9.6 8.5 9.2 8.8 7.0 5.3 6.3 5.0 4.7 PSE Index % change Blended Indexb % Net Blended Indexc % 17.5 (20.0) 8.6 9.6 (13.4) (8.2) (3.7) 27.6 19.0 12.2 27.4 14.6 (25.7) 38.7 23.8 Yea-end Value of Net Blended Indexd 1.0063 1.1813 0.9816 1.0679 1.1637 1.0300 0.9477 0.9104 1.1861 1.3758 1.4974 1.7712 1.9169 1.6598 2.0466 2.2842

CAGR 5.62%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

22.2 (41.0) 5.3 8.8 (30.3) (21.8) (12.8) 41.6 26.4 15.0 42.3 21.4 (48.3) 63.0 37.6

18.0 (20.0) 8.9 9.9 (13.8) (8.5) (3.8) 28.4 19.5 12.5 28.2 15.0 (26.5) 39.8 24.4

CAGR = compound annual growth; PSE = Philippine Stock Exchange; WAR = weighted average interest rate. a Net of 20% final withholding tax. b Based on 60% stocks and 40% 5-year Treasury Notes c Net of 2.8% average expense ratio of the Mutual Fund Company of the Philippines d For comparison purposes, the year-end value of the net blended index in 1995 was the same as the net asset value per share of the Mutual Fund Company of the Philippines in year-end 1995. Sources: Philippine Stock Exchange Fact Books and Annual Reports, Bureau of Treasury, Bangko Sentral ng Pilipinas.

Appendix 4

37

CAPITAL MARKETS OVERVIEW 1. Since about 1993, the Philippines has experienced higher-than-average gross domestic product (GDP) growth relative to other countries in the region, but has consistently lagged other lower-middle-income countries (Figure A4.1). Growth averaged about 4.7% since the end of the Asian financial crisis until the beginning of the recent global crisis, which was first sparked by the large-scale deterioration of asset quality among financial institutions in the United States.

Figure A4.1: Real Gross Domestic Product Growth
12

10

8

6

4

2

0
1998
1991 1992 1993 1994 1995 1996 1997 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

-2
Philippines Lower middle income East Asia & Pacific (all income levels)

Source: World Bank Databank. http://databank.worldbank.org.

2. The latest crisis coincides with a period of steep growth in the ratio of savings to GDP, which first took off after the Asian financial crisis (Figure A4.2). The ratio of gross savings to GDP in the Philippines doubled to 40% in little more than 10 years.

38

Appendix 4

Figure A4.2: Gross Domestic Savings (% of GDP)
45 40 35 30 25 20 15 10 5 0

1997

1991

1992

1993

1994

1995

1996

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Philippines

Lower middle income

East Asia & Pacific (all income levels)

Source: World Bank Databank. Available: http://databank.worldbank.org. 3. At least some of the additional saving has been absorbed by the mutual fund industry, which has grown at a remarkable net financial internal rate of return of more than 30% per year since 1995 (Appendix 1). The growth of the Philippine share markets, on the other hand, has been rather stagnant. Except for the bubble in the first half of the 1990s, market capitalization as a percentage of GDP has been lower than in other countries in Asia (Figure A4.3). Since 1997, this rate has generally stayed within a range of 35%–55%.

2009

Appendix 4

39

Figure A4.3: Stock Market Capitalization (% of GDP)
160 140 120 100 80 60 40 20 0

1991

2003

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2004

2005

2006

2007

2008

Philippines East Asia & Pacific (all income levels) Linear (Lower middle income)

Lower middle income Linear (Philippines) Linear (East Asia & Pacific (all income levels))

Source: World Bank Databank. Available: http:// databank. www.worldbank.org

3. The number of companies listed on the Philippine Stock Exchange (PSE) has increased by little—from about 210 at the time the Asian Development Bank invested in the Mutual Fund Company of the Philippines, to about 250, a number that remains among the lowest in Asia (Figure A4.4).

2009

40

Appendix 4

Figure A4.4: Number of Companies Listed on Major Stock Exchanges
7000

6000

5000

4000

3000

2000

1000

0

2006

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2007

2008

China Indonesia Malaysia Sri Lanka

Hong Kong SAR, China Japan Pakistan Thailand

India Korea, Rep. Philippines

Source: World Bank Databank. Available: http://databank.worldbank.org.

4. Also, while investors have a limited selection of companies to include in their portfolios, they are further limited by the liquidity of the stocks issued. The turnover ratio of stocks traded on the PSE is markedly lower than in other Asian economies and in lower middle-income countries worldwide (Figures A4.5 and A5.6). In 2009, in fact, the volume of turnover on the PSE was slightly lower than in 1995. 5. An assessment of why the Philippine stock market has remained so underdeveloped is beyond the scope of this report.1 Irrespective of its causes, however, the lack of an active and diverse set of issues to trade on the PSE has not presented a large obstacle to the robust growth of household savings, nor has it stopped the mutual fund industry from dramatically
1

Issues of corporate governance and ownership concentration are often cited as chief among likely explanations.

2009

Appendix 4

41

increasing assets under management. Fund managers report that at present, volumes and the number of companies traded are sufficient for the volume of assets under management. However, given the industry’s growth prospects, the lack of breadth and depth of sectors traded on the PSE and very low trading volumes are likely to constrain not only the development of the mutual fund industry, but the overall economy. Figure A4.5: Volume of Stock Turnover on Major Exchanges
600

500

400

Stock turnover (%)

300

200

100

0

2008

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

China Indonesia Malaysia

Hong Kong SAR, China Japan Pakistan

India Korea, Rep. Philippines

Note: Stock turnover ratio is the value of shares traded during the period divided by the average capitalization for the period. Source: World Bank Databank. Available: http://www.databank.worldbank.org.

2009

42

Appendix 4

Figure A4.6: Volume of Stock Turnover on Major Exchanges

180 160 140 120 100 80 60 40 20 0

1993

1991

1992

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Philippines

Lower middle income

East Asia & Pacific (all income levels)

Source: World Bank Databank. Available: http://www.databank.worldbank.org.

6. Figure A4.7 shows end-of-year data for the amount of corporate and government bonds outstanding as a portion of GDP in the Philippines and nine other Asian countries from 2000 to 2010.2 The Philippine bond market has grown on average by about 25% per year since 2000. It was starting from a very low point in 2000, however, and still lags many other Asian countries.

2

Government bonds include obligations of the central government, local governments, the central bank, and stateowned entities. Corporate bonds comprise both public and private companies, including financial institutions and international organizations.

2009

Appendix 4

43

Figure A4.7: Year-End Size of Bond Markets (% of GDP)
200% 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% 2000 China Malaysia 2001 2002 2003 2004 India Singapore 2005 2006 Japan Thailand 2007 2008 2009

Hong Kong Philippines

Korea, Rep. Vietnam

Source: Asian Development Bank. Available: http://www.asianbondsonline.adb.org

7. Figure A4.8 shows corporate bond volumes as a percentage of total bonds outstanding. Corporate bonds make up a much larger share of the market in Hong Kong, Singapore, and Malaysia than in Thailand, India, the Philippines, and Viet Nam. While government debt accounts for nearly 90% of total bonds outstanding in the Philippines, corporate bonds have grown rapidly as a portion of total bonds. Except for Viet Nam, many other peer countries have seen the share of corporate debt stay flat or decline over the same period. The Philippine corporate bond market is also very small as a percentage of GDP (Figure A4.9).

44

Appendix 4

Figure A4.8: Corporate Bonds as Percentage of Total Bond Market
90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 00 01 02 03 04 05 06 07 08 09 10

Hong Kong Philippines

India Singapore

Malaysia Thailand

Source: Asian Development Bank. Available: http://www.asianbondsonline.adb.org

Figure A4.9: Corporate Bond Markets (% of GDP)
45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Hong Kong Singapore

India Thailand

Malaysia Vietnam

Philippines

Source: Asian Development Bank. Available: http://www.asianbondsonline.adb.org

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