Mutual Funds

Concept
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
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  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.
1. Professional management
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.
2. Diversification
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.
3. Liquidity
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.
4. Affordability
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.
5. Tax benefits
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
6. Convenience
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.

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 7. Return Potential
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.
8. Transparency
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.
9. Flexibility
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.
10. Choice of schemes
Mutual Funds offer a variety of product schemes to suit your varying needs and financial goals.
11. Well regulated
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.
Investment Process
Investing in mutual funds involves a 3-step process:
Step 1
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.
Knowing your investor profile will help you work out the kind of investments you should consider.
There are various dimensions to your investment profile:
1. Your Investment Objective
Are you looking to invest for your retirement, a home, your child’s education or a trip around the world?
Regardless of your goal, you need a strategy that provides the right results.
For instance, if you are starting out in your career, you are probably looking to invest with more than one
goal in mind: retirement, a future home, a family and, of course, a well-deserved break at your favorite
destination. Each of these goals requires a different approach.

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 2. Investment Horizon
You will need to determine, whether your investment horizon is short term (less than 1 year), medium term
(1 year to 3 years) or long term (5 years and more). Such a time frame will depend on your current level of
saving/ investment, your risk profile and the goal that you wish to achieve.
With respect to your risk profile, you would normally want to select a longer investment horizon if you are
investing in riskier instruments such as stocks, while a shorter investment horizon will be selected if you are
investing in conservative instruments such as money market instruments.
3. Returns – income or capital appreciation?
Expectation of returns vary with the type of investment that is being considered. Generally, for any
investment the higher the risk higher the return is expected and vice versa.
It may be helpful to think of Returns in a framework that involves either receiving stable income or seeking
capital appreciation.
– If you are seeking current income, then you may want to opt for a product that aims to preserve your
principal value while providing you regular income. In this case a suitable option will be to invest in a
Money Market Fund or an Income Fund.
– If you are looking for capital appreciation, you may select an instrument that aims to provide capital
growth over the long term. In this case, a suitable option can be an equity fund.
4. Liquidity
Liquidity refers to the ability to quickly convert an asset or security or an investment into cash at the
marketplace, without significantly affecting it’s price.
Real Estate, Commodities, etc are usually considered illiquid investments, while cash at bank or with mutual
funds, etc are generally considered to be fairly liquid.
5. Risk
Risk and reward is the classic investor’s balancing act. It is wise to start your investment journey carefully in
order to properly assess your tolerance.
Your risk tolerance level is a key element to defining your investor profile. If your objectives consist of
earning regular income and preserving your capital and high returns are not your priority, a portfolio of low-
risk investments that provide stability may be the perfect solution for you.
If, however, you are building a retirement nest and investing over the long term, you may want to increase
the risk level of your portfolio to boost its growth potential.
The higher the risk you take, the higher returns you could potentially receive, but the more chance you have
of your investments losing value, fluctuating in value, or failing entirely.
With a low-risk investment, you generally know the range of return you will receive right up front but
compared to riskier investments, like equities, the return is not very high. The risks come in two types:
Volatility: The possibility that the value of your investment will fluctuate in either direction.
Performance: The possibility that the investment could fail and you lose all or part of your money – or the
investment gives you a lower return than what you expected.

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 6. Current Level of Wealth
Your current level of wealth helps you determine the level of risk you can tolerate in your investment
portfolio. Investors whose investment portfolios are a small part of their entire wealth are in a better position
to tolerate fluctuations in the value of their portfolios.
Knowing the answers to these questions forms the basis of your investment plan and will help you decide
which investments and Funds are likely to give you the type of returns you are looking for.

Step 2
Choose a mutual fund that suits your investment objective. Mutual Funds offers a range of investment Funds
and products designed to help our clients achieve their investment goals. Their Relationship Managers can
help you choose the investment products and services that fit your needs. They can determine your
investment profile and tailor a plan based on your comfort with risk and timeframe, in order to help you
achieve your goals.
Step 3
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
Therefore, you are required to select appropriate account type, carefully read the Offering Document of your
selected Fund(s), Fill out the appropriate application and submit along with the required payment.
The Close Ended Mutual Funds trade on stock exchange and you need to buy their shares by following the
general procedure adopted to buy shares of listed company. You obtain the services of a stock broker who
buys shares for you and charge his commission.
Problems With Mutual Funds
1. Expenses
Mutual funds can be your friend and your enemy when it comes to expenses. On the plus side, some mutual
funds do not have transaction fee making it a perfect investment vehicle for someone that contribute a small
amount on a regular basis — i.e., automatic investment. On the down side, mutual funds charges annual
expense ratio on the entire investment. For example, if a fund has an expense ratio of 1% and you have
$10,000 in investment, the annual expense is $100. This is not too bad. However, if you have $250,000, the
annual expense is $2,500 — that’s a lot of money!
This disadvantage does not include the many pitfalls, such as upfront load and back-end load.
Upfront load is the amount of money some mutual funds charge for buying your shares. For example, if you
invest $10,000 in a fund that charges 2% upfront load, $200 is deducted right away and only $9,800 is
invested.
Back-end load, or redemption fee, is the amount of money some mutual funds charge for selling your shares.
For example, if you are selling $10,000 out of a fund that charges 3% back-end load, you’ll walk away with
only $9,700.
2. Sub-Optimal Purchases
Mutual funds manager cannot hoard cash. When investors buy shares of a mutual fund, the fund manager
must turn around and buy shares of stocks that fit within certain guideline specified by the prospectus. For
example, if it’s a “Small Value Fund”, the manager cannot buy a “Large Growth” stock even if it represents
a better buying opportunity. Additionally, if there are not enough good buying opportunities to choose from,
the fund manager is forced to buy stocks that are less desirable.
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 3. Over-diversification
Either by design, or as a consequence of the problem explained above, many mutual funds suffer from over
diversification. Basically, the fund has so much cash that it is forced to own hundreds of stocks within its
classification. Consequentially, it is impossible for the fund manager to focus on the high potential stocks
and the mutual fund becomes a closet index fund — i.e., simply reflecting the average within that particular
group.
4. Forced Redemption
Similarly, fund manager is forced to sell stocks when investors sell shares of mutual fund and the fund
doesn’t have enough cash reserve to meet the demand. Since rushes of redemption usually happen when the
market decline sharply — i.e., a correction or a bear market — this is usually the worst time to sell stocks.
However, the fund manager has no choice and has to sell underlying stocks even if it’s not the best financial
decision to do so.
5. Tax Consequences
Lastly, mutual funds have a strange characteristic when it comes to taxes. You could owe tax even if the
value of your investment is going down! When a fund sells a stock for a profit — whether it’s by design or
forced — it passes the tax bill on to you in the form of annual capital gains distribution. If your timing is
bad, for example, you buy just before the fund makes its capital gains distribution or you buy during the year
that the fund manager is taking a lot of profit, you could end up paying a very big tax bill for no good
reason.

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