Chapter Eight
Mutual Funds
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Mutual Funds Overview
• A mutual fund is nothing more than a collection of
stocks and / or bonds.
• Mutual funds are financial intermediaries that pool the
financial resources of investors and invest those
resources in diversified portfolios of assets
• Initially a Mutual fund collect the funds from small
investors, and when sufficient funds are gathered, then
they are invested into the securities
• The fund is divided into the units and each holder is
entitled to a proportionate share of the fund.
• Major fund disclosure document is called prospectus.
• Enjoy economies of scale by incurring lower
transaction costs and commissions
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Mutual Funds Overview
• A mutual fund is managed by a management
company
• The portfolio of mutual fund is managed by a
“Portfolio Manager”
• Shareholder services offered include free
exchanges of investments between a company’s
funds, automatic investing, check-writing,
automatic reinvestment of dividends, and
automatic withdrawals
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Historical Trends
• First mutual fund established in 1924
• Advent of money market mutual funds in 1972
as investors looked for ways to earn market rates
on short-term funds
• Tax-exempt money market mutual funds
introduced in 1979
• Special-purpose equity, bond, emerging market,
and derivative funds exploded on the scene
during the 1990’s
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History of Mutual Funds in Pakistan
• Mutual Funds were introduced in Pakistan in
1962, with the public offering of National
Investment (Unit) Trust (NIT)
• Followed by the establishment of the Investment
Corporation of Pakistan (ICP) in 1966,
• Currently there exists One open end (NIT)
mutual fund in public sector.
• Twelve open-ended and Eighteen closed-ended
mutual funds under private sector management
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Sources of Profit Generation
• A mutual fund can generate profits from
three different sources,
– Dividend
– Capital Gains
– Appreciation of Share Price
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Types of Mutual Funds
• Open Ended Mutual Funds
– Those where subscription and redemption of shares are
allowed on a continues basis or at any time.
– The price at which the shares offered for subscription and
redemption is determined by NAV after adjusting redemption
fee
– The valuation used to be monthly or weekly, but now is almost
universally done on daily basis
– Open Ended Mutual Funds keep some portion of their assets in
short-term and money market securities to provide available
funds for redemption
– A large portion of most open mutual funds is invested in
highly “liquid securities”, which means that the fund can raise
money by selling securities at prices very close to those used
for valuation.
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Open end mutual funds
• Open Ended Mutual Funds
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National Investment Trust (NIT) in public sector
Pakistan Stock Market Fund (PSM)
Pakistan Income Fund (PIF)
Unit Trust of Pakistan (UTP)
UTP Islamic Fund
United Money Market Fund (UMMF)
Dawood Money Market Funds (DMMF)
Atlas Income Fund (AIF)
Meezan Islamic Fund (MIF)
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Types of Mutual Funds
• Closed Ended Mutual Funds
– It is open for a subscription for a fixed duration as specified in
the prospectus of the fund.
– The investor can apply for the units of funds only during the
initial offered period following which unit can be bought and
sold only at the stock exchange where they are listed, at the
market price.
– Closed mutual funds are really financial securities that are
traded on the stock market like stocks or bonds.
– Closed end mutual funds are those where the shares are
initially offered to the public and are then traded in secondary
market
– The trading usually occurs at a slight discount to the NAV
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Close End mutual funds
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Asian Stocks Fund
First Capital Mutual Fund
Golden Arrow Stock Fund
Investec Mutual Fund
Pakistan Premier Fund
Pakistan Capital Mkt Fund
Prudential Stock Fund
Safeway Mutual Fund
Tri-Star Mutual Fund
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Investor Returns from Mutual Fund
Ownership
• NAV - the net asset value of a mutual fund -- equal to the market
value of the assets in the mutual fund portfolio divided by number
of shares outstanding
– NAV reflects the Fund that will be available to the shareholders
if the Fund is liquidated and all liabilities are paid
• Calculation of NAV on an Open-End Mutual Fund
• Net Asset Value of fund = Sum of Market value of Shares + Liquid
Assets /Cash + Dividends/interest – all Liabilities
NAV per unit = NAV of funds
No. of mutual fund shares outstanding
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Types of Mutual Funds
• Long Term
– Equity funds - funds consisting of common and preferred
stock securities
– Bond funds - funds consisting of fixed-income capital market
debt securities, invest in the bonds of government and
corporations
– Hybrid funds - funds consisting of stock and bond securities
• Short Term
– Money market mutual funds – invest in taxable or taxexempt money market securities (with maturity of less that
one year) invest in government treasury bills and the
corporate commercial papers
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Other types of investment funds
• On the basis of objectives
– Growth funds
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Capital appreciation , while the current income may be low
Do not pay dividend instead they reinvest
The fluctuations in share price may be high
Investor with high investment invest
Invest in stocks
NIT, Meezan Islamic, Pak Stock Market funds
– Income funds
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For periodic payments & small investors invest
Fund pays regular income to the investor (dividend)
Provide capital stability & little potential for growth
Fund includes Corporate Debentures, Govt. Securities, Bonds, etc.
UTP Income fund, Atlas Income fund, etc.
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Other types of investment funds
– Balanced funds
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Provide both Growth & regular income
Invest both in equity & debt in certain proportion
The fluctuations in stock price may be low
Generally accepted proportion is 55% equity & 45% debt
Invest in stocks, corporate debts and Govt. Paper.
Unit Trust of Pakistan, Asian Stock Funds, etc.
– Tax saving funds
• Help investor to get tax rebate to the maximum amount of
Rs.10,000
• Tax concession to increase investment
• There is a lock-in period of three years, hence it reduce liquidity.
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Other types of investment funds
• On the basis of composition of assets
– Equity funds
• Invest only in the equity market
• Riskiest as it fluctuates daily due to the volatility in the
stock markets
• Investors looking for capital appreciation invest in it
• Invested in common shares of corporations
• Meezan Islamic fund, UTP , NIT, Pak Stock Market Fund,
etc.
– Debt funds
• Funds invest in debt market
• Provide regular income & Low risky
• Risk averse investors invest in it.
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Other types of investment funds
– Money Market Mutual Funds
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Known as liquidity funds
Invest in short term instruments
T-Bills, Corporate Commercial papers, etc.
Regular payments
Dawood Money Market funds, Pakistan Income Funds,
UTP Income Funds, etc.
– Gilt Funds
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Invest only in Govt. Securities & T-Bills
Timely payments
No credit risk , but the price risk is always present
Short term
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Other types of investment funds
– Index funds
• Invest in stocks that are included in the stock index
• The portfolio of the fund remains almost identical to the
proportion of weights of stocks in the index
• Reputable & profitable stocks have high weights
• Performance of the index funds exactly follows the
performance of stock index.
• Suppose NBP Index weight 5.96% means shares of NBP
are 5.96% of the whole market shares.
– Sector funds
• Invest in the stocks of a particular industry or sector.
• These funds are riskier as they are not diversified
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Mutual Fund Costs
• Mutual funds charge shareholders a price or fee
• Two types of fees are incurred by investors
– Load versus No-load Funds
• Load fund –these funds charges the entry / exit load every time the
investor buys/sells the unit of funds.
– The charges covers the one time processing fee and transaction cost.
– Sell through brokers
– Commission is subtracted from the value of shares & paid at the time of
purchase
• No-load fund - a mutual fund that does not charge commission charges
on the sale of mutual fund shares to investors
– Directly offer to the public with no sales commission
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Advantages of Mutual Funds
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Low risk
Professional management of the investment
Low cost of investments
Diversification
Convenient record keeping and administration
Various types of schemes
Flexibility
Scope of good returns
Enables investing in high value stocks
Easy liquidity
Tax benefits
Provide transparency
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Disadvantages of Mutual Funds
• Economic and Business Conditions
• Portfolio Managed by Managers
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