Historically, Pakistan has had a dismal saving rate — well below its regional peers. This, however, does not necessarily signify a low propensity to save.

Many Pakistanis, especially women, use an age-old, informal saving mechanism known as a “committee”, whereby a group of people pool money each month and the entirety of it goes to one of the participants. The process recurs every month until all the partakers get the sum once.

Committees help people use social ties to save money for expenditures that require a sizable amount of money, well beyond one’s monthly take-home income. Likewise, they are also used as a financing tool, where a person takes the lump-sum money in the earlier months and then pays it off with monthly contributions.

Despite these advantages, committees remain an inefficient way of saving. First, committees do not provide a hedge against inflation. So, while the person who has his/her turn at the end would receive the sum of all the contributions made towards the committee — a considerable amount — that money would actually possess a diminished purchasing power.

Second, committees expose people to significant counterparty risk with no legal recourse in case of fraud, as the contract executed is entirely informal and, in most cases, verbal. Even if there is no ill will involved, a participant might genuinely not be able to make any further contribution due to any unforeseen event, like a layoff. This would adversely impact the equilibrium and the losses will eventually be borne by others.

Investing in mutual funds mitigates the risks and losses in committees while allowing small investors to save

Digital committees do help address the latter issue. These committees are offered by Non-Banking Finance Companies (NBFCs), licensed by the Securities and Exchange Commission of Pakistan (SECP). Therefore, there is regulatory oversight, and such companies undertake stringent Know Your Customer and other compliance checks, limiting counterparty exposure’s downside.

Mutual funds are a worthy alternative to committees. They pool money from investors and invest it in avenues like stocks and bonds. They are managed by professional fund managers who are subject experts and possess the requisite skills, expertise, and knowledge. The profit earned on these investments is subject to the investors’ net management fee and other expenses.

The idea of mutual funds is to provide people exposure to avenues which were otherwise out of their access. Even if they had access to such asset classes, the probability of them yielding a lucrative return would be far less than that of a mutual fund.

The concept of pooling money is not exactly novel in human history. The first modern mutual fund can be traced back to 1924, when the Massachusetts Financial Services’ Massachusetts Investors Trust was launched in the United States. A century later, mutual funds are an integral part of the financial ecosystem and one of the largest investors in the capital markets.

The mutual funds available for Pakistanis locally are open-end schemes, meaning people can invest and redeem at their will. At the time of redemption, they will be entitled to the net return proportional to their investment and time horizon.

Unlike bank deposits, the concept of pari passu — literally, “on equal footing” — applies to mutual funds, which ensures that a person who has invested as low as Rs5,000 will reap the same percentage return as another person with an investment worth billions.

Also, the Asset Management Companies (AMCs) in Pakistan have digitised the account opening, investment, and redemption procedures and are continuously streamlining the processes to make mutual funds more accessible to the masses.

Since AMCs offer different types of mutual funds like equity, income, and money market schemes, investors have a slew of options to choose from. The selection of an appropriate fund will depend on one’s risk appetite and the investment need. Risk-averse investors can opt for money-market mutual funds, while investors with moderate risk appetites can use income funds. Finally, investors having the ability and willingness to take on high risk can invest in equity funds and make the most of the ongoing rally in the stock market.

From an economic viewpoint, transitioning from committee savings to mutual funds can help bring more money into the formal sector. The amount that will be invested via mutual funds in financial assets like stocks and bonds will bode well for financial intermediation in the country, as money will flow from savers with no productive economic activity to companies who can either expand their business or use the money to address their working capital woes.

The writer is a finance professional and a graduate of the Institute of Business Administration, Karachi

Published in Dawn, The Business and Finance Weekly, July 22nd, 2024