A Mutual Fund is a single portfolio of investments where investors put their money to be managed by an asset management company on behalf of its many investors. This allows each investor access to a professional managed pool of funds.
Fund Manager invests the fund’s capital in profitable avenues and attempt to earn a return for the fund’s investors. The income earned through these investments and the capital appreciation realized is shared by its unit holders in proportion to the number of units owned by them.
The flow chart describes broadly the working of a mutual fund:
Constraints for Individual Investors
Individuals and corporate investors can invest directly, without professional oversight, in the market. However, they face the following constraints:
- Lack of expertise to understand and forecast market trends
- Lack of time for an in depth analysis of the various investment avenues or instruments available in the market
- Lengthy procedures for account opening, order placement, execution, delivery, etc.
- Inability to accurately monitor the rapidly changing market
- Inability to diversify by investing in more than one company shares.
Benefits of Mutual Funds
Mutual fund investing offers important advantages especially for individuals who prefer not to be involved directly in the hectic and time consuming process of studying companies and then placing execution orders with brokers tracking price moment of stock.
Mutual Funds keep a team of experienced and skilled professionals for the investment decision making. Team consists of dedicated fund management and investment research team which analyze the performance and prospects of companies and selects suitable investments to achieve the objectives of the fund. The Fund Manager has the experience and resources necessary to follow the markets, select investments, and track their performance.
Diversification is one of the most important benefits of mutual fund investing as it reduces investment risk of concentration. In simple terms it can be explained through below phrase: Do Not Put All the Eggs in One Basket.
Mutual Funds invest in companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. Because of diverse range, the ups and downs of any one security have less effect on the fund’s overall performance. However, though diversification can help reduce the risk and enhance the stability of investment, it does not guarantee loss prevention.
Liquidity simply means being able to access your money when you need it. With mutual funds you can buy and sell units easily, move money among different funds, and redeem.
As a small investor, you may find that it is not possible to buy shares of companies with high share price. Such companies have low share base and high profits as a result investors allocate them higher price. Mutual funds access to pool funds allow to buy securities in market in every price category. Through mutual funds investors can enjoy a diversified portfolio by investing as low as Rs 5,000.
To induce saving habits in general public, Government of Pakistan has given incentive to investor in form of tax rebate. An investor can claim tax rebate by investing in mutual funds and reducing his tax liability to government. Click Here
Also, investments held by investors for a period of 48 months or more qualify for exemption from Capital Gains Tax
Investors remain occupied with their daily task and find it difficult to follow market on daily basis. Mutual funds on other hand acts on your behalf and monitor your investment on minute to minute basis. Being expert in their area, they are also better equipped to make decision on timely basis.
Due to their expertise in investment decision making and availability of dedicated resources, Mutual Funds have the potential to provide a higher return in medium to long term. Mutual funds also have advantage of diversification which reflects in better returns in long term.
Mutual funds are watched by regulators, settlement house (stock exchange), trustee, auditors and in our case Shariah auditor also. Multiple levels oversee and audit builds trust of investor as it makes investment process very transparent.
In addition to this, the Fund also prepares and discloses periodic financial statements, which provide an in-depth review of all the major activities undertaken by the fund over the period.
Mutual Funds provide various value added services which makes it very easy for investors to manage and track their investments. They can even invest or redeem in mutual fund by just sitting at home through online transactions.
Mutual funds have goal based plans such as Systematic Investment Plans (SIP) and Savings Plans which are convenient for investors to invest and achieve their long term objectives such as kids’ education or marriage.
Choice of schemes
Mutual Funds offer a variety of product schemes to suit your varying needs and financial goals.
All Mutual Funds are registered with SECP and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SECP. In addition to that, mutual funds assets are placed with trustee to further ensure investors asset protection.
Shariah compliant mutual funds’ operations are oversight by a renowned Shariah Advisor to ensure the compliance with the Shariah guidelines.
Investing in mutual funds involves a 3-step process:
Identify your financial goals and related investment objectives. For example, for a retirement goal, that may be 15 years away, capital growth would usually be the investment objective. But for a retired person, generating regular income could be the objective. Similarly, other financial needs require identifying relevant investment objectives.
Choose a mutual fund that suits your investment objective. To know more about how to select suitable mutual funds,
Make your investment in the chosen mutual fund. You will receive units which will represent your investment in the fund. The number of units you get will depend on your investment amount and the NAV on the day you make the purchase.
Number of units you get = Your investment value / NAV on the day you make the purchase
It’s as simple as that!
Wide varieties of Mutual Fund exist to cater to varying individual needs and differing circumstances and profile.
Open End Mutual Fund
These funds continually create new units or redeem existing units on demand. The unit holders buy the units of the fund or may redeem them on a continuous basis at the prevailing Net Asset Value (NAV). All that is required, is for the investor to contact the Asset Management Company and the AMC will facilitate in the particular transaction.
Closed End Mutual Funds
Closed end funds have a fixed number of shares outstanding and do not redeem when investors want to sell; instead, the shares trade in the secondary markets (stock markets). Its market price is determined by demand and supply and is not directly tied to its net asset value. In order to buy or sell units of a close ended Mutual Fund, the investor shall need to contact the broker and not the AMC.
|Open End Fund||Closed End Fund|
|You can invest or redeem whenever you like||You can buy/sell units in the stock market|
|Investment and Redemption is very convenient, you can simply contact the Asset Management Company||To buy/sell units you need to contact your broker|
|NAV of fund is available at the end of business day.||The price of the unit is available of the stock market|
By Investment Objectives
Mutual funds can be grouped roughly into following categories according to investment objective.
The objective of equity funds is long-term growth of capital by investing in stocks.
Because stocks are generally more volatile than other type of investments, equity funds (which are usually composed entirely of stocks) may exhibit short-term fluctuation and therefore carry a higher level of risk. Investors need to be prepared to tolerate this higher risk. Equity funds could be a good investment if you have a long-term perspective and can stay invested for at least three years or perhaps even longer.
Types of investments
Equity funds primarily invest in stocks of companies as per the investment objective and philosophy.
The objective of balanced fund is to generate long term capital appreciation as well as current income from a portfolio comprising of both equity as well as fixed income securities.
Balanced funds which have a combination of both equity and fixed income instruments, tend to provide investors with a moderate level of risk exposure. Balanced funds are ideal for those looking for income and growth over medium to long-term investment horizon.
Types of investments
Balanced funds primarily invest in equities as well as in fixed income instruments.
Index Tracker Funds
The objective of index tracker funds is to provide investors an opportunity to track closely the performance of an Index by investing in proportion to the constituent securities found in the index. Being a passive fund, it charges lower management fee from unit holders vs. a pure equity active fund.
The Fund is suitable for investors who may simply wish to mirror the risk and return profile that is achieved by investing in any particular index.
Index Funds that track an equity index, simply aim to mirror the return of the subject index. It must be noted that these are risky investments, since the underlying securities are usually equity securities with their inherent volatility intact. However, the fund manager has no discretion on the choice of security, other than to passively invest in the constituent equity securities in the weightages, as found in the subject index.
Types of investments
Index funds are 100% replica of a particular index.
The objective of income funds is to have a regular stream of income by investing in debt securities that have the potential to provide a higher level of regular income than money market funds and may also generate reasonable capital growth.
Fixed income funds are usually safer investment avenues than stock funds, but maybe slightly more riskier than money market funds. As is the case with other Fixed Income securities, their prices and performance is heavily dependent on the level and change in interest rates (and other market conditions). These are usually suitable for investors who want to avoid the high volatility experienced in the stock market.
Types of investments
Fixed income funds primarily invests in Govt. Securities, Banks, Sukuks, TFC, TDR, CFS, Certificate of Musharka, Spread Transactions etc.
Money Market Funds
The objective of money market funds is to invest in low risk avenues.. These funds aim to preserve your original investment and achieve target returns with high certainty and low risk factor by investing in investment instrument with low risk and lower volatility.
Money market funds are considered fairly safe and appropriate for investors who want to limit risk or who are investing for a short period of time and want ready access to their money. Money market funds have very low risk of losses in principal invested along with higher certainty of target return achievement.
Types of investments
Money Market funds primarily invests in highly rated Govt. Securities, Banks, Sukuks, TFC, TDR, CFS, Certificate of Musharka, etc
Asset Allocation Funds
The objective of an asset allocation fund is to generate returns by investing in a mix of equity and debt securities (or any other asset class that may be included as well) .
Asset allocation funds are suitable for investors who have the comfort on the fund manager to prudently switch between the various asset classes, as per market outlook.
Types of investments
Asset Allocation funds usually shift their exposures between debt and equity (and/or any other asset class) as per the outlook on the market.
Capital Protected Funds
The investment objective is to protect Initial Investment Value along with the prospect of growth upon the initial investment over the stipulated time period.
Capital protected funds are suitable for investors who do not wish to take any significant risk and are seeking the potential for improved returns above those available on money market/debt funds or bank deposits. They seek participation to equity markets with the assurance that their initial principal is protected or safeguarded.. Feature of capital protection is normally offered if the investment is held till maturity.
Types of investments
Capital protected funds give you 100% capital protection, with the potential to earn a return that is better than that being offered by bank deposits or money market funds/ instruments. In order to achieve their objective they may seek to cash-in on any stock market upside that may be witnessed during the tenure.
Voluntary Pension Funds
The investment objective is to provide participants a regular income at the time of retirement and at an age when one’s capacity to work is diminished, so that one is not dependant on other members of the society.
Voluntary Pension schemes in Pakistan normally have 3 sub- funds and based on these sub-funds offer various attractive allocation schemes. Each scheme may carry a varying level of risk. For a participant investment risk range from low to high (depends on the chosen asset allocation).
Types of investments
Investor can choose from a wide range of investment options depending on retirement goals, age and appetite for risk. Contributions will be invested in the particular scheme.
How does a mutual fund operate?
Each mutual fund scheme adheres to a specific investment objective while investing the money collected from investors. The investor is allotted units for his investment amount depending on the prevailing NAV of the fund.
The value of each unit of the fund is calculated based on the current market price of all the assets held by the fund. This price is called the Net Asset Value (NAV) of the fund.
The total of assets held by the mutual fund at any point of time is called its Assets under Management (AUM). At launch, the AUM is equal to pooled funds collected from the investors. As time passes, funds are invested in assets whose value changes on daily basis reflecting in profits/losses. At the same time, new investments keep coming in, and existing investors redeem or dividend is paid to them.
Risks involved with investing in a mutual fund?
Like any other market linked investment, mutual funds too are subject to price fluctuation, liquidity, credit risks, etc. Mutual funds however, minimize these risks through diversification and professional management. Performance of mutual funds is dependent on the investments in the portfolio.
Which funds are right for you?
Your optimal mutual fund portfolio will depend on your investment goals, your time frame, and your risk tolerance.
Your investment goals
Why are you investing? People invest for a lot of good reasons:
- Children’s education
- Buying a house
- Helping protect retirement savings against inflation
- Earning additional current income
Before you invest, you need to ask yourself what you want to accomplish.
Your time frame
How much time till you will need the money? By dividing your goals into long- and short-term, you’ll make selecting the right investments a lot easier:
- Long-term investing gives you the opportunity to go for potentially higher returns by taking on more risk.
- Short-term investing generally means you need to focus on preserving the value of your principal with more conservative investments.
Your risk tolerance
How much risk are you willing to take? Every investment involves some degree of risk. You have to decide how you feel about risk:
- If you are looking for higher returns then you may have to invest in equity funds with higher volatility..
- If you are looking to reduce risk then you will have to seek out for income or money market mutual funds that typically offer lower potential returns.
The main thing is that you find a comfortable balance between potential risk and potential earnings.
Tracking the performance of mutual funds
Periodic monitoring of the performance of the mutual fund schemes you have invested in is important as it enables you to take timely decisions in case you need to convert or exit from the fund. There are useful tools which can help you to monitor your mutual fund investments. A Fund Managers Report (FMR) is one such valuable document published by Al Meezan. It is just like a performance report card that indicates the health of the scheme by enlisting details and performance of each of the schemes managed by the us. It is usually published on a monthly basis,
FMR is available on the website for investors view or download. You should periodically refer to this document to keep track of your investments. Click here to read or download our Fund Managers Report.
You can also read analysts’ reports in the media on the performance of the mutual fund scheme. There are a number of websites that offer in-depth analysis of mutual fund schemes in terms of comparable schemes, the benchmark index and average performance of all schemes in the category the scheme falls in.
Mutual Funds returns
Mutual fund schemes offer returns to the investors in following ways:
- Dividend and/or Profit Income- A mutual fund may earn income in the form of dividend, or profit on the assets held in the portfolio. The income earned may be distributed by AMC to its unit holders.
- Capital Gains- The value of any asset or security held by a mutual fund may increase overtime. When a fund sells an asset or security at a price higher than the purchase cost, capital gains are realized by the fund. At the end of financial year, mutual funds distribute capital gains to its unit holders.
- Increased Net Asset Value- If the market value of a fund’s portfolio increases after the adjustment of expenses and liabilities it is reflected in the increased Net Asset Value of the fund. The higher the net asset value higher is the investment value.
Some of the Costs and expenses involved in mutual fund investing
The mutual fund incurs certain recurring expenses for managing the scheme which is charged to the scheme. Some of these expenses are:
- Administrative and establishment expenses in proportion to the scheme assets.
- Brokerage and other transaction costs.
- Fund management fees to the AMC.
- Fees for various service providers involved, such as Trustees, Registrar & Transfer Agents, Custodian and Auditors.
- Scheme advertising expenses and commissions to the distributors.
- Cost incurred on investor communication, account statements, dividend / redemption cheques.
- Fees pertaining to the listing of the scheme.
- Regulator fee