IN many developing countries, including several middle-income countries in Asia and the Pacific, the mutual funds industry has displayed considerable progress in recent years. Although Pakistan had an early start with the setting up of NIT in 1962 and subsequently the ICP mutual funds, for almost 40 years, until 2002, the progress made was lackadaisical at best. In fact, the industry suffered both as a consequence of poor management as well as the government intervention and the distortions thus induced.
During the past five years, prompted by positive changes in the government policy and regulation, as also measures to privatise and allow new entrants, the industry has witnessed major improvements.
The aggregate size of the local funds industry that was Rs25 billion in 2002 has now grown to Rs190 billion, i.e. over $3 billion, which is spread over some 61 funds that are managed by 34 asset management companies. Rs145 billion are in open-end funds and the rest is in closed-end funds.
The total assets under management are, however, only two per cent of GDP or 5.8 per cent of bank deposits or 6-7 per cent of market capitalisation. By way of comparison, India’s mutual fund industry is six per cent of GDP, 13.4 per cent of bank deposits, and around 10-12 per cent of market cap, whereas in the United States mutual funds are about 70 per cent of GDP, over 150 per cent of bank deposits, and about 20-25 per cent of market cap. Also, it is noteworthy that the industry in Pakistan has come out with a fairly wide range of mutual fund products.
In fact, the mutual funds industry of Pakistan deserves to be applauded for its excellent achievements. There are, however, several challenges to overcome! Both absolute and relative size of the industry remains rather small by international standards, its management is fragmented, its funding mostly comes from institutions and not from retail investors, its IT endowment is weak, its human capital is poor, and it has to contend with a shallow pool of investable assets.
The question now is, what should be done to enhance our mutual funds industry in order that it clearly plays its role of underpinning the financial markets and serves as an effective channel for mobilising resources and allocating them to productive uses. This is not a perfect world, never has been, nor will it be! There will always be constraints and issues which will need to be addressed. If mutual fund managers are competent, they will know how to deal with difficulties and make progress but if they are not, they won’t.
To say, for instance, that by once again permitting institutions to invest in national savings instruments has posed inordinate difficulties for mutual funds is not very convincing since the returns on NSS instruments have been drastically slashed over the years, and in any case, mutual funds must target retail investors, not institutions, if they are to play their proper role. Actually, with banking spreads being 7-10 per cent and mutual fund fees being 1½-2 per cent, mutual fund managers have a lot of room to manoeuvre.
Nonetheless, it is sincerely believed that policy makers and regulators will take the responsibility to adopt a progressive view of mutual funds and will take such measures as are necessary so as to enhance the effectiveness of the industry as an important pillar of the financial system. Now the question is, what steps should they take or promote. The several relevant measures which appear obvious are submitted below:
First, policy makers should not distinguish between government securities and mutual funds accredited with high investment grade ratings with regard to bank reserve requirements, permissible provident fund investments etc. As far as possible, let there be a level playing field between investing in mutual funds and in government securities.
Second, policy makers should adopt cogent measures to promote the provision of pension and retirement benefits to a substantial part of the population and clearly this would not be feasible without the involvement of competent fund managers.
Third, regulators must pro-actively encourage innovation and new product development, and the promotion of mutual funds based on such products, as well as asset classes like derivatives, commodities or real estate, and also viable schemes to extract value from special situations that can be rolled out for investment by retail investors through the mutual fund structure.
Fourth, there are certain obvious flexibilities which must be allowed to mutual funds which will not only be an operational boon for them but also serve to substantially reduce the deep discounts to NAV at which closed-end funds are currently traded. Within certain reasonable, prudential parameters, mutual funds should be allowed to hedge their positions through the use of derivatives, borrow and leverage their positions, sell short, lend securities, and buy back their own certificates in the open market. At present, mutual fund mangers are handicapped by the inability to do all this. As a consequence, management of a fund’s portfolio suffers and this is reflected in the price of the fund’s certificates.
Fifth, it is important to address the issue of governance of mutual funds, which, if tackled effectively, should serve to reduce the deep discount to NAV suffered by closed-end mutual funds. Some form of accountability of fund managers to the fund certificate holders should be introduced through structures such as the convening of annual meetings of certificate holders, establishing advisory boards, or through other suitable ways.
The code of conduct for mutual fund managers may need to be strengthened in line with international best practice. In particular, mutual fund managers need to adhere to sensible guidelines regarding representation in annual meetings and boards of investee companies, grant of proxies etc. Furthermore, most importantly, compliance procedures need to be strengthened with, among other matters, the appointment of independent compliance officers reporting directly to the Board.
Sixth, There should be no harm in permitting dedicated mutual funds catering to sophisticated investors only e.g. large institutional investors. It should be possible to permit the setting up of such mutual funds without prior regulatory approval, with only registration being required under a somewhat light regulatory regime. Savvy fund managers will thus be able to garner large amounts to manage and reap the benefits of economies of scale. Some professionals may even be able to start business by setting up such mutual funds, and having gained the necessary experience, move on to managing the usual retail mutual funds.
Seventh, with the increase in size of mutual funds, regulators may need to re-visit the question of regulatory fees. In case this fee is determined to be excessive, it can be either appropriately reduced, or alternatively, the excess amount suitably deployed under trust arrangements, and in consultation with Mutual Funds Association of Pakistan (MUFAP), to develop the mutual funds industry, fund manager training, investor education etc.
Having dealt with what policy makers and regulators must do, a vexing and the most relevant issue which needs to be addressed in reference to growth of mutual funds is the paucity of investable securities, especially debt securities for money market and debt funds.
It is a “chicken-and-egg” type situation with many corporates finding it somewhat difficult to issue debt securities in the absence of money market mutual funds, and on the other hand, there is a lack of such funds because debt securities are scarce. Money market and debt funds, of course, fill the demand side of the equation, and it is in their interest, therefore, to encourage the supply side. And this is exactly what they should be doing. They should be pro-active in this connection and team up with investment banking outfits to promote the issuance of debt securities by corporates.
In an emerging market environment, mutual funds cannot sit back and wait for issuance of securities to be arranged by investment houses. Asset management companies in developing countries have to act as quasi-investment banks and promote the issuance of securities. It is believed that if mutual fund managers are competent and business-like, they will find a way to ensure the availability of investable securities.
And lastly, insofar as MUFAP is concerned, it must conduct itself in a manner that is beyond reproach. It should not be parochial and should not let itself be dragged down to defending the narrow business interests of its constituents. Rather, it must be seen to be professional, sensible, above board, and wedded to the overall sound development of the financial system.
It must take visible steps to ensure that mutual fund managers conduct their activities with integrity, act in investors’ interests, and remain both transparent as well as accountable. The aim should be that mutual funds get recognition as institutions that provide the vast majority of individual investors the most efficient and effective access to securities markets they can achieve. To succeed in all this, it would be best if MUFAP is professionally managed by a duly empowered Chief Executive.
In developing countries, mutual fund associations as well as mutual fund managers, acting on their own, should be at the forefront in the struggle to –
• Protect the investor; raise standards of corporate governance; improve disclosure standards, and; curb the use of insider trading and other forms of market abuse.
It is certain that if any mutual funds association proceeds in this manner and makes sincere efforts to realise these goals, it will not have to seek self-regulatory organisation status; rather, it will have this SRO status thrust upon it by the regulators! There is no doubt that MUFAP can do it. There are examples around the world of this for MUFAP to emulate. And later, MUFAP itself be an example for others.
The writer is the Chairman, Monopoly Control Authority.
IN many developing countries, including several middle-income countries in Asia and the Pacific, the mutual funds industry has displayed considerable progress in recent years. Although Pakistan had an early start with the setting up of NIT in 1962 and subsequently the ICP mutual funds, for almost 40 years, until 2002, the progress made was lackadaisical at best. In fact, the industry suffered both as a consequence of poor management as well as the government intervention and the distortions thus induced.
