MUTUAL FUNDS - RISK AND RETURN PERSPECTIVES

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MUTUAL FUNDS

R I S K A N D R E T U R N P E R S P E C T I V E S

B A S I C R E S E A R C H

Instructor DR. SHABIB HAIDER

Prepared By: MUSTANSIR SHABBAR

ROLL NO. 072264 MPA PREVIOUS FINAL (FINANCE)

JANUARY – JUNE 2009

DEPARTMENT OF PUBLIC ADMINISTRATION

UNIVERSITY OF KARACHI

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TABLE OF CONTENTS

ACKNOWLEDGEMENT………….………………………………………………………….3

CHAPTER I – BACKGROUND OF STUDY………….………………………….4 INTRODUCTION ....................................................................................................... 5 OBJECTIVE ............................................................................................................. 6 SIGNIFICANCE OF THE STUDY ................................................................................... 7 SCOPE AND LIMITATIONS ......................................................................................... 7 ASSUMPTIONS ........................................................................................................ 8 DELIMITATION ......................................................................................................... 8

Chapter II – Literature Review………………………………………...9 MUTUAL FUNDS AS AN ECONOMIC MOBILIZER ......................................................... 10

MUTUAL FUNDS DISCLAIMER ................................................................................................... 11

MUTUAL FUNDS CHARACTERISTICS ......................................................................................... 11

ADVANTAGES AND DISADVANTAGES ........................................................................................ 12

MUTUAL FUNDS CATEGORIES .................................................................................................. 14

MUTUAL FUNDS FOR HOUSEHOLD INDIVIDUALS ..................................................................... 16

MUTUAL FUNDS FOR INSTITUTIONS ......................................................................................... 17

MUTUAL FUNDS IN PAKISTAN ................................................................................. 17 MUTUAL FUNDS YIELD .............................................................................................................. 19

MUTUAL FUNDS GROWTH AND INCENTIVES ............................................................................ 20

UNDERSTANDING MUTUAL FUNDS RISK .................................................................. 22 RISK CATEGORIES ..................................................................................................................... 23

KEY STATISTICS FOR SCREENING MUTUAL FUNDS……...…………………….25 A. MUTUAL FUNDS RETURNS ................................................................................. 26

1. ABSOLUTE RETURNS ........................................................................................................ 26

2. ANNUALIZED RETURNS ..................................................................................................... 26

3. MONTHLY RETURNS .......................................................................................................... 27

4. ANNUAL / YEARLY RETURNS ............................................................................................ 28

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5. PAYOUT OR DISTRIBUTION ............................................................................................... 29

B. MUTUAL FUNDS RISK ........................................................................................ 29 1. DURATION .......................................................................................................................... 30

2. STANDARD DEVIATION: ..................................................................................................... 32

3. ACTIVE RETURN OR ALPHA .............................................................................................. 33

4. BETA .................................................................................................................................. 35

5. R-SQUARED ....................................................................................................................... 36

C. MUTUAL FUNDS PERFORMANCE......................................................................... 37 1. RISK-ADJUSTED RETURN – RAR ..................................................................................... 38

2. COEFFICIENT OF VARIATION – CV ................................................................................... 40

3. SHARPE RATIO .................................................................................................................. 41

4. TREYNOR RATIO ................................................................................................................ 42

5. JENSEN’S ALPHA ............................................................................................................... 44

6. INFORMATION RATIO – IR ................................................................................................. 45

D. NON-QUANTITATIVE RISK ASSESSMENTS ........................................................... 47 1. SELF-ASSESSMENT OF RISK ............................................................................................ 47

2. RISK MANAGEMENT PROCEDURES .................................................................................. 47

Chapter III – Summary………………..……………………………………………….49 CONCLUSION ........................................................................................................ 50 RECOMMENDATIONS ............................................................................................. 52 BIBLIOGRAPHY ..................................................................................................... 54 ABBREVIATIONS ................................................................................................... 57 APPENDICES ........................................................................................................ 59

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ACKNOWLEDGEMENT I thank to the Almighty Allah for giving me strength, courage, patience and inspiration to complete this Research Report. I am also very sincerely grateful for the efforts of those who have contributed to the successful completion of this piece of work. I am especially thankful to my course coordinator Dr. Shabib Haider for his guidance, help, advice and encouragement that led to the successful completion of this report. I am also very much thankful to my company Dawood Capital Management Limited and its executives and colleagues for their precious time given to me for discussion and research materials provided to me. On the basis of the contributions to this report, it is necessary to list the names of persons who have provided me guidance in completion of this report. I am very much thankful to:

1. Mr. Jamal Tariq, Assistant Manager Research, Alfalah Securities Limited, Mutual Funds Distribution Section.

2. Mr. Adeel Durrani, Mutual Funds Research Analyst, Atlas Capital Markets (Pvt.) Limited.

Last but not least, I must appreciate the efforts of all respondents including employees of MUFAP, Asset Management Companies, Research Firms and Investment Facilitators who have supported me in my research. Mustansir Shabbar MPA Previous Final – Finance July 2007 – June 2009 Evening Program

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CHAPTER I

BACKGROUND OF STUDY

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INTRODUCTION A mutual fund is a collective investment scheme, which specializes in investing a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. It is indirect mode of investing. There are two types of mutual funds by structure, open end and closed end. In Pakistan mutual fund is constituted as a trust. It has a Trustee, Sponsor, Asset Management Company (AMC), Registrar and Custodian. Fund is established by Sponsors. Trustee holds the property of the fund in its custody for the benefit of the investors and hence acts as a custodian as well. Registrar keeps the data of all the investors either electronically or on paper. AMC is approved by Securities and Exchange Commission of Pakistan (SECP) being a regulator and all investment will be done in a fund according to the guidelines provided by the SECP. Mutual funds are the most popular method of indirect investing around the globe. Mutual funds have a vital role in the economy of the county. Globally it is considered as a great booster in the capital formation of any country. The history of mutual fund probably began in 1924 when the very first mutual fund was created by three Boston securities executives when they pooled their money together to form Massachusetts Investor Trust. Today in the US there are over 10,000 mutual funds available. These mutual funds are collectively worth more than 10 trillion dollars divided by 93 million investors. Almost every individual in US invests in the mutual funds to utilize his/her idle money to generate healthy returns according to his/her risk appetite. Almost every commercial bank in the western countries provide their account holders to invest in the mutual funds through their accounts in the form of IRAs (Individual Retirement Accounts), in fact, every commercial bank owns a some kind of mutual fund to cater the needs their clients. It shows how much popular and useful tool mutual funds are for the economy of the western countries. Mutual funds have a very important role in the economy of Pakistan as well. In Pakistan mutual fund started in 1966 with the establishment of National Investment Trust (NIT). But actual mutual funds gained its popularity after 2003 and now we have about 28 AMCs offering about 120 different kinds of mutual funds (both open and closed end) depending upon the investors needs. Mutual funds are our one of the major sources of employment as thousands of people

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are engaged with this industry. In Pakistan all AMCs have jointly created a body, MUFAP (Mutual Funds Association of Pakistan) in order to safeguard the interest of the AMCs and to ensure a healthy market for their smooth operations. It does not only provide a good investment alternative to the investors at grass root levels but also fuels the economy by providing necessary capital from surplus agents to deficit agents. They are also one of the major sources of employment as well. The major advantages of mutual funds are:

1. Diversification 2. Reduced transaction cost 3. Tax free returns 4. Risk Reduction

Risk and reward are the part and parcel of every investment. Every investment involves certain level of risk related to its reward. Without risk the life would be very easy. Investment decision would no longer required prior analysis and only few financial instruments and analytical methods would exist. But risk in inherent in every financial security, so the mutual funds. Every investor has to decide on his/her risk tolerance i.e. how much risk they are willing to incur to generate maximum returns on investment. No investors can expect more returns without assuming greater risk and if any one who is not willing to incur risk must be satisfied with risk free rate of return. Mutual funds have their own unique kinds of risks associated with their investments policies and objectives. It is difficult to quantify the risk of a particular security and very difficult to quantify the risk of the entire portfolio. Various analytical and mathematical tools are available to measure the risk of a mutual fund portfolio which will be explored in the report.

OBJECTIVE The goal of this study to enhance the knowledge about the importance of mutual funds with reference to risk and return perspectives. Different models will be presented to calculate the return as well as the risk associated with them.

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SIGNIFICANCE OF THE STUDY This study will provide useful information about the mutual funds as an excellent investment tool which is not only used in our economy but globally it serves as a common way to generate returns to beat the inflation rate.

SCOPE AND LIMITATIONS i) This study will cover the analysis of the data of the open end mutual funds

operating in Pakistan. ii) The data will be available through publications by AMCs on monthly basis

and by MUFAP. iii) The study includes fixed-income / money market and stock funds (till June

2008, no proper boundaries were defined for fixed-income / money market funds).

iv) Mutual funds having a complete track record in their category during the last three years from July 2005 to June 2008. The reason is that during this tenure, the AMC industry had shown a great improvement not in terms of returns but in terms increased assets under management as well.

v) Only pure categories will be included i.e. money market / fixed-income and stock based funds.

vi) Only conventional funds are included, because Islamic funds market is still very nascent and started to grow during 2007 and no adequate data is available for proper research.

vii) Following funds are included in the study: A. Money Market / Fixed-Income Funds

a) Dawood Money Market Fund – DMMF Managed by Dawood Capital Management Limited – DCM Ltd.

b) Pakistan Income Fund – PIF Managed by Arif Habib Investments Management Ltd. – AHIML

c) United Money Market Fund – UMMF Managed by UBL Fund Managers – UBLFM

d) JS Income Fund – JSIF Managed by JS Investments Limited – JSIL

e) Atlas Income Fund – AIF Managed by Atlas Asset Management Limited – AAML

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B. Stock Funds

a) National Investment Trust – NIT Managed by National Investment Trust – NIT

b) Pakistan Stock Market Fund – PSM Managed by Arif Habib Investments Management Ltd. – AHIML

c) Atlas Stock Market Fund – ASMF Managed by Atlas Asset Management Limited – AAML

d) Crosby Dragon Fund – CDF Managed by Crosby Asset Management - CAM

ASSUMPTIONS

i) Facts and figures presented in the research reports and publications are true.

ii) Analysis provided is solely based on the analyst view point which may include his/her subjectivity about the market conditions.

iii) The data and investors’ perception may change during the preparation of this report.

DELIMITATION Following will not be included in the research:

i) Funds that have the mixture of two or more categories. ii) Data before July 2005 and after June 2008. iii) Changes in the circumstances and methodologies after June 2008. iv) Changes in the regulations that govern the financial markets. v) Any changes occurred during the preparation of the report.

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CHAPTER II

LITERATURE REVIEW

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MUTUAL FUNDS AS AN ECONOMIC MOBILIZER The success story of any economy can only scripted on the basis of sound financial system. During the last century mutual funds emerged as an indispensable tool for stabilizing the economy; and mobilizing and channelizing the savings of millions of individuals and institutions. Today mutual funds are playing significant role in providing financial services in the financial industry throughout the World. The successful economies of developed western countries including USA and other European countries have trillions of dollars invested in mutual funds. Approximately every individual in US invests in mutual funds. Also our neighbor India has more than 800 billion of dollars invested in mutual funds which is considered as the largest market of Asia and there is a prediction that it will cross $1 trillion up to 20151. Investors can invest directly by buying and selling securities by themselves, typically through their own brokerage accounts. They have direct control over them. They have wide varieties of securities available to choose. But investing directly requires extensive knowledge of financial markets which a common person does not have. For them, indirect investing is the best option. It involves leaving the investment decisions to others, technically to professional experts. Mutual funds are the best available option for indirect investing, which offers professional fund managers to manage the portfolio of securities on behalf of investors. A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments. The combined holdings the mutual fund owns are known as its portfolio. Each share represents an investor's proportionate ownership of the fund's holdings and the income those holdings generate2. Purchasing a mutual fund which holds a portfolio of securities is to purchase an ownership interest in that portfolio of securities. Investors are entitled to a pro rata share of dividends, interest and capital gains generated. Investors must also 1 Rao, P. Hanumantha and Mishra, Vijay Kr., “Mutual Fund: A Resource Mobilizer in Financial Market”, in

Vidyasagar University Journal of Commerce, Vol. 12, March 2007, p. 111. 2 Invest Wisely: An Introduction to Mutual Fund, U.S. Securities and Exchange Commission,

http://www.sec.gov/investor/pubs/inwsmf.htm.

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pay a pro rata share of the company’s expenses and its management fee, which will be deducted from the portfolio’s earnings as it flows back to the investors1. American investors increasingly have turned to mutual funds to save for retirement and other financial goals. Mutual funds can offer advantages of diversification and professional management. But, as with other investment choices, investment in mutual funds involves risk. And fees and taxes will diminish a fund’s returns. It pays to understand both the upsides and the downsides of mutual funds investing and how to choose products that match your goals and tolerance of risk2.

MUTUAL FUNDS DISCLAIMER U.S. SEC on his website published several educational literatures for investors’ education and learning. It has stated few key points to remember for mutual funds investing:

i) Mutual funds are not guaranteed by FDIC or any other governmental agency – even if you buy through a bank and the fund carries the bank’s name. You can lose money investing in mutual funds.

ii) Past performance is not a reliable indicator of future performance. So do not be dazzled by last year’s high returns. But past performance can help you assess a fund’s volatility over time.

iii) All mutual funds have costs that lower your investment returns. Shop around, and use a mutual fund cost calculator at www.sec.gov/investor/tools.shtml to compare many of the costs of owning different funds before you buy.

MUTUAL FUNDS CHARACTERISTICS Some of the traditional and distinguishing characteristics of open end mutual funds include the following: 1 Jones, Charles P. (2005‐06), Investments Analysis and Management, 10th edition, California, p. 50. 2 Invest Wisely: An Introduction to Mutual Fund, U.S. Securities and Exchange Commission,


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Investors purchase shares from the fund or investment company itself (or through a broker for the fund) instead of from other investors on a secondary market.

The price that investors pay for mutual fund shares is the fund's per share net asset value (NAV) plus any shareholder fees that the fund imposes at the time of purchase (such as sales loads).

Mutual funds generally create and sell new shares to accommodate new investors. In other words, they sell their shares on a continuous basis to new investors. There is no limit on their capitalization and keeps on changing every day.

Mutual fund shares are also "redeemable," meaning existing investors can sell their shares back to the fund or investment company at any time.

The investment portfolios of mutual funds typically are managed by separate entities known as "investment advisers" that are registered with the SEC (Regulator).

ADVANTAGES AND DISADVANTAGES Every investment has advantages and disadvantages. But it's important to remember that features that matter to one investor may not be important to another. Whether any particular feature is an advantage for one will depend on one’s unique circumstances. For some investors, mutual funds provide an attractive investment choice because they generally offer the following features1: Professional Management — Professional money managers research, select, and monitor the performance of the securities the fund purchases. Diversification — Diversification is an investing strategy that can be neatly summed up as "Don't put all your eggs in one basket." Spreading your investments across a wide range of companies and industry sectors can help lower your risk if a company or sector fails. Some investors find it easier to achieve diversification through ownership of mutual funds rather than through ownership of individual stocks or bonds.

1 Invest Wisely: An Introduction to Mutual Fund, U.S. Securities and Exchange Commission,


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Affordability — Some mutual funds accommodate investors who don't have a lot of money to invest by setting relatively low amounts for initial purchases, subsequent monthly purchases, or both. Liquidity — Mutual fund investors can readily redeem their shares at the current NAV — plus any fees and charges assessed on redemption — at any time. But mutual funds also have features that some investors might view as disadvantages, such as: Costs Despite Negative Returns — Investors may have to pay sales charges, annual fees, and other expenses regardless of how the fund performs. And, depending on the timing of their investment, investors may also have to pay taxes on any capital gains distribution they receive — even if the fund went on to perform poorly after they bought shares. Lack of Control — Investors typically cannot ascertain the exact make-up of a fund's portfolio at any given time, nor can they directly influence which securities the fund manager buys and sells or the timing of those trades. Price Uncertainty — With an individual stock, you can obtain real-time (or close to real-time) pricing information with relative ease by checking financial websites or by calling your broker. You can also monitor how a stock's price changes from hour to hour — or even second to second. By contrast, with a mutual fund, the price at which you purchase or redeem shares will typically depend on the fund's NAV, which the fund might not calculate until many hours after you've placed your order. In general, mutual funds must calculate their NAV at least once every business day, typically after the major exchanges close. Despite few disadvantages, investors in U.S. other European countries choose to invest with mutual funds more aggressively especially household investors because their advantages have overcome their disadvantages in long run. Now mutual funds have are of first choice of them when it comes to investing. Now it is concluded that when it comes to investing, most of the western household investors opt for mutual funds. But investors have literally thousands

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of choices. Before you invest in any given fund, decide whether the investment strategy and risks of the fund are a good fit for you. The first step to successful investing is figuring out your financial goals and risk tolerance — either on your own or with the help of a financial professional. Once you know what you are saving for, when you will need the money, and how much risk you can tolerate, you can more easily narrow your choices.

MUTUAL FUNDS CATEGORIES Mutual funds are generally categorized broadly in the following:

Money Market Mutual Fund Equity (Stock) Fund Bond Fund Hybrid (Balanced) Fund

Money market fund invests in short-term high quality investments issued by the government, corporations, local governments and municipalities. Money market funds are appealing to the investors for the following reasons:

No sales and redemption charges Average maturity ranges from 1-3 months, thus providing liquidity Any time redeemable (being and open end) Interest earned which is ongoing in the market Interest is credited on daily basis Diversification and professional management Safety of capital

Equity (stock) fund invests in the stocks of the companies. They are highly risky and volatile as their value rise and fall very quickly depending on the performance of the stock market. Equity funds are generally divided into two categories based on their approach to selecting stocks1:

Value fund generally seeks to find stocks that are cheap on the basis of standard fundamental analysis yardsticks, such as earnings, book value and dividend yield. They focus on dividends on the stocks.

1 Jones, Charles P. (2005‐06), Investments Analysis and Management, 10th edition, California, p. 61.

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Growth funds, on the other hand, seek to find companies that are expected to show rapid future growth in earnings, even if current earnings are poor or, possibly, non-existent. They focus on large capital gain rather than dividend.

Bond fund invests in bonds of issued by both Government and private corporations. They are riskier than money market funds because they aim to earn higher returns. Hybrid (balanced) fund invests in the combination of stock and bonds thus providing the combined features of both bond and stock funds. Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you. Investors can earn money from mutual funds in three ways:

1. Dividend Payments — A fund may earn income in the form of dividends and interest on the securities in its portfolio. The fund then pays its shareholders nearly all of the income (minus disclosed expenses) it has earned in the form of dividends.

2. Capital Gains Distributions — The price of the securities a fund owns

may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, most funds distribute these capital gains (minus any capital losses) to investors.

3. Increased NAV — If the market value of a fund's portfolio increases after

deduction of expenses and liabilities, then the value (NAV) of the fund and its shares increases. The higher NAV reflects the higher value of your investment.

With respect to dividend payments and capital gains distributions, funds usually will give you a choice: the fund can send you a check or other form of payment,

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or you can have your dividends or distributions reinvested in the fund to buy more shares (often without paying an additional sales load)1.

MUTUAL FUNDS FOR HOUSEHOLD INDIVIDUALS Investment Company Institute Face Book 2009Mutual funds in are not only the source for employment but majority of the households in opt for mutual funds for their various needs including savings and investment, retirement plans and education. They are so easy to invest that an individual can get a direct access to any investment company and can invest with them without any hassle. The literature provided by them is also very easy to understand.

Table 1: Investment Company Institute Face Book 2009, p. 149.

1 Invest Wisely: An Introduction to Mutual Fund, U.S. Securities and Exchange Commission,


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MUTUAL FUNDS FOR INSTITUTIONS They provide efficient tool for institutions including nonfinancial institutions for cash management and alternative investment vehicle for both short-term and long-term. Huge portions of employers managed retirement plans are invested with mutual funds. Financial advisors of investment companies provide advisory services and suggesting strategies to a large number of households to meet financial goals.

MUTUAL FUNDS IN PAKISTAN Mutual funds in underdeveloped countries like in Pakistan are still in its developmental phase and the market is very nascent unlike Americas where they are at their peak. In Pakistan, investment companies depend largely on the institutional money and very small number of household is investing with them. Households who have invested are majority related to these financial institutions itself or they are highly educated. Mutual funds have a very important role in the economy of Pakistan as well. In Pakistan mutual fund started in 1962 with the establishment of National Investment Trust (NIT) and public offering of NIT which is an open end fund. In 1966 another company Investment Corporation of Pakistan (ICP) was established which offered a series of 26 closed end mutual funds. In 2002, government started the privatization of ICP and ABAMCO Limited acquired 12 funds of ICP (ABAMCO was later acquired by Jahangir Siddiqui & Company). Rest of the funds were acquired by PICIC Asset Management Company Limited. Initially there was both public and private sector participation in the management of these funds, but with the nationalization in the seventies, the Government role become more dominant. Later, the government also allowed the private sector to establish mutual funds. Currently there are more than 120 mutual funds with 28 AMCs at the end of Financial Year 2008. In the last few years mutual fund industry has shown significant progress with reference to saving mobilization and important part of the overall financial markets. But still we are far behind the developed countries mutual fund industry. Growth in mutual funds worldwide is because of the overall growth in both the

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size and maturity of many foreign capital markets. These nations have increasingly used debt and equity securities rather than bank loans to finance economic expansion. The Pakistan economy can prosper because of the benefits of new investment opportunities arising from economic reform, privatization, lowered trade barriers and rapid economic growth1. Individuals throughout the world have the same basic needs that are education for their children, health, good living standard and comfortable retirement. In our country where people are religious minded, mostly they avoid bank schemes for investments, if they are provided an investment opportunity which suits the religion, we can mobilize savings from masses which may be laying an idle money at present. By doing so we would be able to improve the living standard of our countrymen through economic prosperity. This can be achieved through the introduction of different species of mutual funds and their performance. The success of this sector depends on the performance and the role of regulatory bodies. Excellent performance and stringent regulations will increase the popularity of mutual funds in Pakistan2. Considering the customs of the people of Pakistan, State Bank of Pakistan allowed Islamic Banking Services to various bankers which also lead to the establishment of Islamic Mutual Funds. SECP has given and is still giving licenses to the AMCs to carry out Shariah Compliant investment advisory services in the form of Islamic Mutual Funds and currently Islamic mutual funds industry is equally competing with the conventional industry in categories. SECP in its Circular No. 07 of 2009 ref: NBFCD/MF/CIRCULAR/2009/292 in consultation with Mutual Funds Association of Pakistan (MUFAP) had devised the following categories for the open end schemes:

1. Equity Scheme 2. Balanced Scheme 3. Asset Allocation Scheme 4. Fund of Funds Scheme 5. Shariah Compliant (Islamic) Scheme

1 Aamir Shah, S.M. and Hijazi, Syed Tahir, “Performance Evaluation of Mutual Funds in Pakistan”, in The

Pakistan Development Review 44:4 Part II, Winter 2005, p. 865. 2 Aamir Shah, S.M. and Hijazi, Syed Tahir, “Performance Evaluation of Mutual Funds in Pakistan”, in The

Pakistan Development Review 44:4 Part II, Winter 2005, p. 866.

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6. Capital Protected Scheme 7. Index Scheme / Index Tracker Scheme 8. Money Market Scheme 9. Income Scheme 10. Aggressive Fixed Income Scheme

MUTUAL FUNDS YIELD Mutual funds are higher yielding alternatives than bank accounts and other government savings schemes and extremely liquid – anyone can withdraw his/her money anytime without penalty with just 3-6 days notice. They are available in low-medium-high risk profiles depending on the investors risk tolerance and their short-term and long-term objectives. Mutual funds by law have to distribute over 90% of their profits to investors in order to get tax advantages. Investors in banks only get as small share in their contribution to economic growth. Investors in mutual funds, however, get the full fruit of all profits made. Following table shows the payout results of financial year 2008 of 65 open end funds including both conventional and Islamic: Fund Category Total

(PKR) % of

Category % of Total

Count

Income / Money Market Funds Conventional 199.19 95% 48% 24 Islamic 11.46 5% 3% 4 Total 10.65 100% 51% 28

Equity Funds Conventional 14.40 85% 27% 14 Islamic 20.75 15% 5% 4 Total 35.15 100% 32% 18

Hybrid Funds Conventional 55.62 79% 13% 13 Islamic 15.14 21% 4% 6 Total 70.76 100% 17% 19

Payout Grand Total 4 16.56 65 Table 2: DCM Research

Fund Category Total % of Total

Count

Conventional 369.21 89% 51 Islamic 47.35 11% 14 Payout Grand Total 416.56 100% 65 Table 3: DCM Research

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Above tables show that the market for Islamic mutual funds is still very small and nascent as compared to the conventional funds and needs more accent. It also shows a lot of room available for Shariah Compliant products if focused properly. Investment in a mutual fund not only offers benefits to the saver, but also the corporate sectors. The fund, money market or equity, can help the corporate sector meet its financing needs, and in the process pass the benefits along to their investors.

MUTUAL FUNDS GROWTH AND INCENTIVES For the above reasons the asset under management were increased in mutual funds as compared to percentage of bank deposits every year (figure 16). After 2007, it was declined in June 2008 and December 2008 due to the financial crisis and households including institutions withdrew money from the mutual funds in bulk amounts. It was followed by the freeze of the stock market which locked up the liquidity of the investors and they had no choice except to redeem their holdings from the mutual funds to meet their liquidity requirements.

Figure 1: SBP Economic Data and DCM Research

Further, mutual funds have many tax benefits that appeal to high income earnings since individuals gain a tax credit for the amount they invest in mutual funds. Many mutual funds especially, money market funds offer very low minimum amount of investment to start which encourages the investors of low income brackets to go for mutual funds.

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

Jun-2002 Jun-2003 Jun-2004 Jun-2005 Jun-2006 Jun-2007 Jun-2008

Ban

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its P

KR

. Bill

ion

AUM

as

% o

f Ban

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Open-End Mutual Fund v/s Bank Deposits

Bank Deposits Pkr. Bln. AUM as % of Bank Deposits

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Mutual funds have made a spectacular growth in the past three years. Asset under management as on June 2002 were merely 25 billion which have increased substantially over the years and as on June 2006, these stood at Rs.175 billion, as on June 2008 Rs. 300 billion (USD 4 billion) and as at December 2008 Rs. 175 billion (USD 2.1 billion)1. There is a massive reduction of approximately 40 percent, due to the financial crisis which hurt the mutual funds the greatest. Compare this to India’s approximately USD 63 billion as at December 20082, we are a long way behind. There are twenty eight Assets Management Companies/Investment Advisors registered with Mutual Funds Association of Pakistan. These companies are currently managing 121 open and closed end mutual funds. The private sector is playing an increasingly prominent role in the sector and currently holds about 50 per cent of the total industry size. However, with the impeding privatization of NIT (a public sector company) holding 50 per cent of the total industry size, the mutual fund industry will become the exclusive domain of the private sector. This moving of mutual fund industry into the private sector is a very healthy sign for the future of the industry. It would boost its growth and new people will come into the market which will be beneficial for its well being3. These days, the increasing innovation in products is helping to cater to the requirements of all types of investors – risk averse, return orientated as well as Shariah Complaint investors now having a large array of products to choose from. However, the industry is still in the dire need of more or different products in the market to address the different trends/preferences of the investors. Moreover, the State Bank of Pakistan now allows mutual funds to invest 30 per cent of their assets abroad or US $ 15 million (whichever is lower)4. This initiative will allow fund managers to diversify their portfolios which will mitigate risk and enhance investor confidence in mutual funds5.

1 MUFAP Sources, www.mufap.com.pk 2 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the Investment

Company Industry, p. 167 3 MUFAP , Country Report Pakistan 2007. 4 Ibid. 5 Ibid.

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These days, the MUFAP is playing an active role in the promotion and growth the industry. The governing regulator, SECP has setup a stringent regulatory framework for the industry and with the recent amendments in the NBFC Rules (Notified Entities Rules 2007), the regulator has become more vigilant in light of the ever increasing number of mutual funds and asset management companies coming into the market. The mutual fund industry already meets stringent standards in terms of how funds conduct their business. For example, it is mandatory for all assets management companies and their funds to acquire a rating, while weekly reporting of assets and liabilities of funds is also required. Moreover, the trustee structure, governed by NBFC Rules 2003 and 2007, ensures that the custody of all assets in the funds is held with the trustee on behalf of the investors. The trustee structure provides yet another independent safeguard for the investors. Despite the substantial progress made by Pakistan’s mutual funds industry during the past 3-4 years and strong regulatory presence, Pakistan’s mutual funds industry is still in the early stages of development. The industry still needs to do a lot more to be able to attain a comparable position at least with the mutual funds industry in India let alone those in the developed world.

UNDERSTANDING MUTUAL FUNDS RISK Understanding of risk and return is the first and basic step towards investing. Every investment involves certain degree of risk, so the mutual funds. They are not free from risk. Although they are the useful tool to generate good returns on investments as compared to others options available in the market with hassle free investments, it definitely involves some degrees of risk as well. Before investing in mutual funds, rational investors must decide on their risk tolerance and financial condition and then choose the right category of mutual fund. It is better to take advice from any financial advisor which the mutual fund company offers to its clients. Balancing risk and return is a dilemma that every investor faces. But armed with the appropriate knowledge, quantitative tools and data, investors can maximize

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their portfolio's return at the level of risk that is appropriate for them1. The first and broadly accepted concept of mitigating risk is diversification. Diversification means not to put all eggs in one basket. All rational investors must hold fully diversified portfolios to mitigate their aggregate risk associated. They more you diversify, the less risky your portfolio will be.

RISK CATEGORIES Risk can be categorized as Specific and Systematic. Specific Risk is diversifiable risk also referred to as company-specific risk or non-systematic risk. It is the aggregate risk that is specific to each company, arising from such things as managerial expertise, R&D, patents, pending law suits, labor relations, supplier relations, customer relations, etc. Specific risk also includes micro economic factors specific to each industry that affect all firms in an industry, such as seasonal fluctuations in demand and the prices of input commodities2. Systematic Risk, non diversifiable risk, also known as market risk, consisting of macro-economic factors such as inflation, war, fluctuating exchange rates, etc., cannot be diversified away and therefore is the residual risk that all investors are faced with and must be factored into their balance between risk and return3. Investing in mutual funds involves following types of risks4: Call Risk. The possibility that falling interest rates will cause a bond issuer to redeem—or call—its high-yielding bond before the bond's maturity date. Country Risk. The possibility that political events (a war, national elections), financial problems (rising inflation, government default), or natural disasters (an

1 Your Complete Guide to investing in Mutual Funds, http://www.investing‐in‐mutual‐funds.com/risk‐and‐

return.html#investment 2 Ibid. 3 Your Complete Guide to investing in Mutual Funds, http://www.investing‐in‐mutual‐funds.com/risk‐and‐

return.html#investment 4The Financial Planning Center, Mutual Fund Risk, http://www.open‐

ira.com/Education_Center/3c_Mutual_Fund_Risk.htm

24

earthquake, a poor harvest) will weaken a country's economy and cause investments in that country to decline. Credit Risk. The possibility that a bond issuer will fail to repay interest and principal in a timely manner. Also called default risk. Currency Risk. The possibility that returns could be reduced for Americans investing in foreign securities because of a rise in the value of the U.S. dollar against foreign currencies. Also called exchange-rate risk. Income Risk. The possibility that a fixed-income fund's dividends will decline as a result of falling overall interest rates. Industry Risk. The possibility that a group of stocks in a single industry will decline in price due to developments in that industry. Inflation Risk. The possibility that increases in the cost of living will reduce or eliminate a fund's real inflation-adjusted returns. Interest Rate Risk. The possibility that a bond fund will decline in value because of an increase in interest rates. Manager Risk. The possibility that an actively managed mutual fund's investment adviser will fail to execute the fund's investment strategy effectively resulting in the failure of stated objectives. Market Risk. The possibility that stock fund or bond fund prices overall will decline over short or even extended periods. Stock and bond markets tend to move in cycles, with periods when prices rise and other periods when prices fall. Principal Risk. The possibility that an investment will go down in value, or "lose money," from the original or invested amount.

25

KEY STATISTICS FOR SCREENING MUTUAL FUNDS When it comes to mutual fund investing, it requires proper screening and comparison of mutual funds to figure out which one is worthy to be included in the portfolio keeping in mind the risk tolerance. To screen out any mutual fund, following key statistics should be followed:

A. Mutual Fund Returns • Absolute Returns • Annualized Returns • Monthly Returns • Annual / Yearly Returns • Payout, Distribution, Dividend or Bonus

B. Mutual Funds Risk

• Duration • Standard Deviation • Active Return or Alpha • Beta • R-squared

C. Mutual Funds Performance

• Risk-Adjusted Return • Coefficient of Variation • Sharpe Ratio • Treynor Ratio • Jensen’s Alpha • Information Ratio

D. Non-Quantitative Risk Assessment Approaches

• Self-Assessment of Risk • Risk Management Procedures

26

A. MUTUAL FUNDS RETURNS When we come to mutual funds comparison, mutual funds historic returns are the first thing most of us look at, and it is what we are looking for. Mutual funds historic returns are generally total returns which include all payouts and distributions subtracting expense and charges such as load, management fee, regulator fee, commissions and other expenses.

1. ABSOLUTE RETURNS It is the return generated by the mutual fund in excess of its par NAV or starting NAV. For example, if the starting NAV of the mutual fund is 100 and after certain time period it rises up to 110, then 10 is the absolute increase and 10% is the absolute return. It is generally used for stock based funds. It is calculated as:

After June 2008, MUFAP has introduced Morning Start formula for calculating mutual funds returns. According to Morning Star, it is calculated as:

1

2. ANNUALIZED RETURNS It is the return generated by the mutual fund in excess of its par NAV or starting NAV annualized for the period or number of days. For example, if the starting NAV of the mutual fund is 100 and after 180 it rises up to 105, then 5 is the absolute increase and 10.13% is the absolute return (365 days a year). It is generally used for money market / fixed-income funds. It can be calculated as:

365

.

27

According to Morning Star, it is calculated as:

.

1

3. MONTHLY RETURNS Monthly return is the return generated by the mutual fund during the particular month under study. It is a useful measure for the investors who are either short term and use mutual funds for short term money parking or speculators who want to gain the benefit of short term expected market fluctuations. It is calculated as:

365.

Average Monthly Returns: Funds 2006

% 2007

% 2008

% Money Market / Fixed Income Funds (Annualized for 30 days) DMMF 11.20 10.65 9.62 PIF 9.68 10.21 8.83 UMMF 8.99 9.81 8.87 UTPIF 10.87 9.73 9.16 AIF 10.94 9.79 9.05 Overall Average 10.34 10.04 9.11 Stock Funds (Absolute) NIT 2.28 3.24 (0.39)PSM 2.35 2.32 (0.04)ASMF 2.49 2.66 (0.34)CDF 1.40 4.51 3.08 Overall Average 2.13 3.18 0.58 Table 4: FMRs and DCM Research


1

28

.

1

4. ANNUAL / YEARLY RETURNS Annual return is the return generated by the mutual fund after completion of its financial year. It is the useful measure for investors having long term horizons at least one year for their investments. Generally institutional investors consider annual returns for evaluating mutual funds. It is calculated as:

365.

Annual Returns: Funds 2006

% 2007

% 2008

% Money Market / Fixed Income Funds (Annualized for 30 days) DMMF 11.77 11.18 10.06 PIF 10.11 10.70 9.06 UMMF 9.35 10.26 9.10 UTPIF 11.41 10.17 9.45 AIF 11.49 10.23 9.32 Overall Average 10.83 10.51 9.40

Stock Funds (Absolute) NIT 28.32 44.83 (6.82) PSM 26.85 29.41 (3.01) ASMF 31.49 29.39 (6.84) CDF 15.09 62.55 35.10 Overall Average 24.48 40.45 8.42 Table 5: FMRs and DCM Research


1

.

1

29

5. PAYOUT OR DISTRIBUTION Mutual funds payout or distribution is also one of the important and crucial criteria for performance screening in terms of returns. According to law, mutual funds have to distribute at least 90% of earnings to get the tax advantages. Some mutual funds distribute cash dividends and some distribute bonus shares or units. The payout can be monthly, quarterly or yearly. Investors who want to earn a regular stream of income to meet their expenditures opt for mutual funds with more frequency of payouts i.e. monthly or quarterly. Table 2 and 3 shows the payout statistics for 2008 of entire mutual funds industry including conventional and Islamic funds. Following table shows the payouts of funds for last 3 years under comparisons: Money Market / Fixed-Income Funds

Funds 2005-06 2006-07 2007-08

Payout Earning %

% of Earning

Payout Earning %

% of Earning

Payout Earning %

% of Earning

DMMF 11.53 11.77 97.95 10.90 11.18 97.50 10.25 10.06 101.89

PIF 5.00 10.11 98.91 5.25 10.70 98.13 4.75 9.06 104.86

UMMF 10.00 9.19 108.78 10.10 10.26 98.44 9.14 9.03 101.18

JSIF 60.50 11.36 106.51 53.30 10.05 106.07 9.72 * 9.45 102.86

AIF 57.50 11.49 100.09 50.00 9.93 100.70 47.50 9.32 101.93

Total / Average 144.53 10.74 102.36 129.55 10.41 100.12 81.36 9.38 102.53

Table 6: Source = Annual Reports, Announcements and DCM Research * In 2008, JSIF face value changed from Rs. 500 per share(unit) to Rs. 100 per share (unit)

Stock Funds

Funds 2005-06 2006-07 2007-08

Payout Earning %

% of Earning

Payout Earning %

% of Earning

Payout Earning %

% of Earning

NIT 5.28 28.32 186.46 6.20 44.83 138.30 6.50 (6.80) 955.88 PSM 30.00 26.81 223.80 25.00 29.41 170.01 17.00 (3.03) 1,122.11 ASMF 125.00 30.11 83.03 100.00 29.39 68.05 37.50 (6.82) 109.97 CDF 15.00 15.09 99.41 38.00 62.55 60.76 30.00 35.00 85.71 Total / Average 175.28 24.23 136.23 169.20 39.46 99.30 91.00 3.26 317.10 Table 7: Source = Annual Reports, Announcements and DCM Research * In 2008, funds paid from their reserves because of negative earnings due to market crash

B. MUTUAL FUNDS RISK When it comes to investing in mutual funds, investors must understand about the risk associated with them. Investors must decide on their risk tolerance and then

30

decide mutual funds. Every mutual fund has its own risk according to its investment horizon. Stock funds are highly risky because of high volatility in stock market whereas money market / fixed-income funds are less risky because of fixed and guaranteed rates and low market volatility. It is not easy to measure risk as a single numerical figure. For the past several years, analysts have closely studied and still studying the feasibility of developing standardized, quantitative measures of mutual funds risk1. Unfortunately, in our market, risk is calculated on historical performance basis and no standardized method has been developed to calculate expected risk and returns.

“If somebody can come up with a single way of defining risk, I think that is wonderful. Of course, they would need to be able to predict the future in detail.”

A. Michael Lipper, president of Lipper Analytical Services Inc. (as reported in the October 9, 1995 issue of Newsday)

The effort to apply a single yardstick of a fund’s risk would be not only fruitless, but also highly counterproductive, creating far more problems than it solves. The different concepts of risk cannot be captured in a single measure. Risk encompasses many different concepts and, consequently, evades reduction to a single quantitative measure. There are varying methods of risk quantification and risk mitigation are identified for mutual funds. We will consider methods which are very popular among entire mutual funds industry.

1. DURATION Duration is a measure for interest rate sensitivity. The change in the value of a fixed income security that will result from a 1% change in interest rates. It applies to bond (money market / fixed-income) fund. For example, 5 year duration means the bond will decrease in value by 5% if interest rates rise 1% and increase in value by 5% if interest rates fall 1%. Duration is a weighted measure of the length of time the bond will pay out. Basically, duration is a weighted average of the maturity of all the income streams from a bond or portfolio of bonds2. Higher the 1 Investment Company Institute, Perspective, Volume 1, Number 2, November 1995, p. 6 2 Investorword.com, http://www.investorwords.com/1602/duration.html

31

duration, higher is the interest rate risk. Interest rates change with changing economic conditions and can impact value of invested portfolio. Duration Formula

Calculation of Duration Consider a two-year bond with 4 coupon payments every six months of Rs. 50 and a Rs. 1000 face value, duration (in years) will be:

0.550

1200 150

1200 1.550

1200 250

1200 210001200 1.875 684.375

Interest Rate Sensitivity Formula

Calculation of interest rate sensitivity A. Consider a +1% interest rate change in the market, with NAV of Rs. 10:

10 1.875 1% 0.19 0.19 Valuation Loss

B. Consider a +1% interest rate change in the market, with NAV of Rs. 10:

10 1.875 1% 0.19 0.19 Valuation Gain

Higher duration in upward trending interest rates can hurt a fund’s return while downward trending interest rate risk gives fund managers a chance to enhance returns. Fund managers monitor duration of a fund to control interest rate risks and enhance return. Duration statement tells your fund manager’s stance on interest rates and how much interest rate risk they have assumed. Long term government bonds carry high interest rate risk while T‐Bills carry a very low risk.

32

Limitation Duration is one of many good examples of the limitations of the available quantitative risk measures. It estimates only interest rate risk, and provides no information regarding credit, currency, or other risks. In fact, using duration to measure fixed-income fund risk could be more harmful than beneficial, exaggerating the importance of one risk element over others1.

2. STANDARD DEVIATION: A statistical measure of the historical volatility of a mutual fund or portfolio. More generally, a measure of the extent to which numbers are spread around their average2. Standard deviation, which measures performance volatility, is another instructive example. To obtain a meaningful sample for computation, standard deviation would likely have to be based on monthly or quarterly returns (thus, the SEC proposed monthly returns over three years as a possible timeframe over which to measure standard deviation). It is far from clear, however, how meaningful the volatility of monthly returns would be for a fund shareholder investing for the long term. Such an investor would probably view risk as the likelihood of a decline in investment value, or the failure to meet a benchmark, over a long term time horizon. In fact, it appears that most investors do view risk in this manner.8 There is no reason to think that a measure of short-term volatility will correspond to the risk of longer-term underperformance. Indeed, our research suggests that the two have a slightly negative correlation3.

Limitation Standard deviation, measures the past variability of a fund’s return. Under certain conditions, it can be used to compute a range or confidence interval that would, on average, contain future returns about two thirds of the time. Many investors, however, are not likely to understand standard deviation or its limitations. Investors—especially the many viewing risk as the likelihood that a fund will underperform—may be confused that a fund gaining five percent one month, ten percent the next month and one percent the month after will have the same standard deviation as a fund losing five percent one month, ten percent the next 1 Perspective, Investment Company Institute, Volume 1, Number 2, November 1995, pp. 6‐7. 2 Investorwords.com, http://www.investorwords.com/4688/standard_deviation.html 3 Perspective, Investment Company Institute, Volume 1, Number 2, November 1995, p. 7.

33

month and one percent the month after. They also may not appreciate that a fund losing a constant two percent per month will have a standard deviation of zero1.

3. ACTIVE RETURN OR ALPHA Return relative to a benchmark. It is the difference of portfolio’s return and its benchmark. A benchmark is the standard against which the performance of mutual fund or any security can be measured. It is the return in excess of the compensation for the risk borne2. In Pakistan, the benchmark of stock funds is KSE-100 index and money market / fixed-income funds is average 6 months KIBOR. Balanced and hybrid funds use the combination of both benchmarks depending on their authorized investments. A fund generating positive alpha is considered as well managed and negative alpha as poorly managed. Zero alpha means that the fund is performing with its benchmark. Negative alpha denotes that the fund manager failed to beat even its benchmark. This ratio translates that the investors must choose among the funds having high positive alpha.

In the following performance table, stock funds alpha values are highly volatile as compared to money market / fixed-income funds but also generating high returns as well. One should be very careful while choosing on the basis of Alpha measure. Again the investors’ risk tolerance will play a vital role here. Following table shows the Alpha results of few funds:

1 Perspective, op. cit., pp. 8‐9 2 Wikipedia, http://en.wikipedia.org/wiki/Alpha_(investment)#column‐one

34

Benchmarks Jun-06 Jun-07 Jun-08 6M KIBOR 9.24 10.36 10.45 KSE-100 34.07 37.87 (10.77)

Money Market / Fixed-Income Funds

DMMF Returns 11.77 11.18 10.06 Alpha 2.53 0.82 (0.39) PIF Returns 10.11 10.70 9.06 Alpha 0.87 0.34 (1.39) UMMF Returns 9.34 10.26 9.10 Alpha 0.10 (0.10) (1.35) JSIF Returns 11.36 10.05 9.45 Alpha 2.12 (0.31) (1.00) AIF Returns 11.49 10.23 9.32 Alpha 2.25 (0.13) (1.13)

Stock Funds

NIT Returns 28.32 44.83 (6.82) Alpha (5.75) 6.96 3.95 PSM Returns 26.85 29.41 (3.01) Alpha (7.22) (8.46) 7.76 ASMF Returns 31.49 29.39 (6.84) Alpha (2.58) (8.48) 3.93 CDF Returns 15.09 62.55 35.10 Alpha (18.98) 24.68 45.87 Table 8: FMRs and DCM Research

35

4. BETA The beta coefficient, in terms of finance and investing, describes how the expected return of a stock or portfolio is correlated to the return of the financial market as a whole rather than the fund’s own mean. An asset with a beta of 0 means that its price is not at all correlated with the market; that asset is independent. A positive beta means that the asset generally follows the market. A negative beta shows that the asset inversely follows the market; the asset generally decreases in value if the market goes up and vice versa1. It is calculated for Stock based funds. Formula for Beta Calculation:

,

Beta is also referred to as financial elasticity or correlated relative volatility, and can be referred to as a measure of the sensitivity of the asset's returns to market returns, its non-diversifiable risk, its systematic risk or market risk2. As noted above, in a well-diversified portfolio, total risk is equal to systematic risk, as the specific risk has presumably been diversified away. Following table shows the Beta calculation of Pakistani Stock Funds:

Funds 2006 2007 2008

NIT 0.70 0.56 0.71

PSM 0.25 0.65 0.73

ASMF 0.63 0.71 0.80

CDF 0.40 0.96 1.12 Table 9: FMRs and DCM Research

The table shows that Pakistani stock funds are weakly related to the benchmark index (KSE-100) on the basis of beta calculation or last three years.

1 Wikipedia, http://en.wikipedia.org/wiki/Beta_coefficient 2 Ibid.

36

Limitation Beta would correlate the fund’s historical returns with those of a benchmark index. That beta is a relative measure illustrates another limitation: it is only useful to the extent the fund’s performance is correlated with that of a benchmark index. For many funds, an appropriate index may not exist. Many equity funds have very little correlation with indices (as we have seen above). Beta is also likely to provide useful information to investors only if they understand the volatility of the index. It is doubtful, however, that many investors—even those familiar with—will demonstrate familiarity with how volatile an index has been1.

5. R-SQUARED The R-squared statistic should be reported along with beta. R-Squared is the measure of correlation between a fund and the market (benchmark). It is calculated by regressing the fund against an appropriate index over time (KSE-100). Values range between 0 and 1. The higher the value of R-Square, the greater the correlation between the two2. It is the coefficient of determination, which tells you what percent of the movement in the fund is explained by movement in the benchmark used in the regression analysis. The KSE-100 is the benchmark most commonly used for this purpose. The higher the R-squared, the more reliable beta is as a measure of probable variation. R-squared is also the square of the correlation coefficient, as such it will give you some idea of the degree of correlation between a fund and the benchmark but, as the square root of a number is an absolute value, you won't know whether R is positive or negative. It also won't tell you how a fund behaves relative to other funds in your portfolio. But R-squared is still useful for screening, as low values indicate that a fund may have good diversification potential and therefore warrants a closer look3. An R-squared of 1 means that all movements of a fund are completely explained by movements in the index. R-squared can be used to ascertain the significance of a particular beta or alpha. Generally, a higher R-squared will indicate a more

1 Perspective, Investment Company Institute, Volume 1, Number 2, November 1995, p. 10. 2 Morningstar.com, http://www.morningstar.com/invglossary/r_squared_definition_what_is.aspx 3 Your Complete Guide to Investing in Mutual funds, http://www.investing‐in‐mutual‐funds.com/mutual‐

fund‐risk.html

37

useful beta figure. If the R-squared is lower, then the beta is less relevant to the fund's performance1. Following Table shows the R-Squared figures of Stock Funds:

Funds 2006 2007 2008

Beta R-Squared Beta R-Squared Beta R-Squared

NIT 0.70 0.72 0.56 0.61 0.71 0.94

PSM 0.25 0.15 0.65 0.84 0.73 0.89

ASMF 0.63 0.88 0.71 0.92 0.80 0.97

CDF 0.40 0.24 0.96 0.45 1.12 0.82 Table 10: FMRs and DCM Research

A higher R-squared value will indicate a more useful beta figure. For example, if a fund has an R-squared value of close to 1 but has a beta below 1, it is most likely offering higher risk-adjusted returns. A low R-squared means you should ignore the beta2. Together, beta and R-squared provide some insight to the probable degree of correlation between a fund and the general market. They won't actually tell you the degree of correlation, but they can provide a hint as to whether a particular fund has good diversification potential. If it looks like a fund may have good diversification potential, it may end up being a better addition to your portfolio than some other fund that wins on a the risk-to-return basis3.

C. MUTUAL FUNDS PERFORMANCE On the basis of risk several methods have been identified to track the performance of the mutual funds considering risk as a quantifiable measure. Mutual fund performance must be evaluated on a risk-to-return basis, as neither risk or return alone provides a sufficient means of evaluation. Together they describe the tradeoffs investors need to make to assemble a portfolio that is at least relatively efficient and is consistent with their level of risk aversion4. 1 Morningstar.com, http://www.morningstar.com/invglossary/r_squared_definition_what_is.aspx 2 Investopedia.com, http://www.investopedia.com/terms/r/r‐squared.asp 3Your Complete Guide to Investing in Mutual funds, http://www.investing‐in‐mutual‐

funds.com/screening‐mutual‐funds.html 4 Ibid, http://www.investing‐in‐mutual‐funds.com/mutual‐fund‐performance.html

38

The following statistical procedures can be used to screen mutual funds on a risk-to-return performance basis:

1. RISK-ADJUSTED RETURN – RAR Risk-adjusted returns are a pseudo measure of risk-to-return, as such they form an intuitive bridge between return and risk and risk-to-return. Risk-adjusted returns are always subject to scrutiny, as they are not always calculated in the same manner. One way to calculate risk-adjusted returns is by dividing mutual fund returns by standard deviation then multiplying by a relevant benchmark's standard deviation. This will give you returns that are relative to the benchmark on a risk-to-return basis. This method is useful in case of stock funds.

′

In the following performance table RAR of 2.55 means that NIT was underperformed by its benchmark of KSE-100 index by 2.55 percentage points or 5.58*% on risk-adjusted basis in 2006. Whereas in 2008, RAR of NIT was 4.09 showing that it had outperformed KSE-100 index by 1.22 percentage points or 42.55% on risk-adjusted basis. Stock Funds Funds 2006 2007 2008

Return RAR Beat % Return RAR Beat % Return RAR Beat %

KSE-100 2.70 2.88 (0.63)

NIT 2.28 2.55 (0.15) -5.58% 3.24 4.09 1.22 42.25% (0.39) (0.49) 0.14 22.44%

PSM 2.35 3.38 0.69 25.40% 2.32 3.00 0.12 4.20% (0.04) (0.05) 0.58 91.54%

ASMF 2.49 3.43 0.73 27.10% 2.66 3.31 0.43 15.06% (0.34) (0.39) 0.24 38.46%

CDF 1.40 1.58 (1.12) -41.52% 4.51 2.90 0.03 0.94% 3.08 2.29 2.92 463.19%

Table 11: FMRs and DCM Research * Returns are absolute

Other way to calculate RAR which is mainly used for money market / fixed income funds, is taking a difference of fund’s return and its benchmark.

′

39

Risk-free rate: It is the baseline from which the returns of all risky investments are measured. This is based on the notion that there is a risk-free rate of return embedded in the return of all risky investments. Short-term T-Bills are usually used as a proxy for the risk-free rate, although even they include an inflation premium, all-be-it nearly insignificant1. Risk-free rate is a theoretical interest rate that would be returned on an investment which was completely free of risk. The 3-month Treasury Bill is a close approximation, since it is virtually risk-free2. In theory, the risk-free rate is the minimum return an investor expects for any investment because he or she will not accept additional risk unless the potential rate of return is greater than the risk-free rate3. In the following performance table, the RAR of DMMF in 2006 is +3.14 which means it has earned a return of 3.14 percent points in excess of risk-free rate and 39.01% on risk adjusted basis. The table shows that money market / fixed-income funds are quite efficient in beating risk-free rate thus providing investors handsome spread for their risk borne. Money Market / Fixed-Income Funds Funds 2006 2007 2008

Return RAR % Return RAR % Return RAR %

3M T-Bill 8.05 8.63 8.69 8.69

DMMF 11.20 3.14 39.01% 10.65 2.03 23.52% 9.62 0.93 10.75%

PIF 9.68 1.62 20.17% 10.21 1.59 18.41% 8.83 0.14 1.60%

UMMF 8.99 0.94 11.65% 9.81 1.18 13.71% 8.87 0.18 2.10%

UTPIF 10.87 2.81 34.94% 9.73 1.11 12.85% 9.16 0.47 5.45%

AIF 10.94 2.89 35.84% 9.79 1.16 13.48% 9.05 0.37 4.22%Table 12: FMRs and DCM Research

1 Your Complete Guide to Investing in Mutual Funds, http://www.investing‐in‐mutual‐funds.com/mutual‐

funds‐glossary.html#riskfree 2 Investorwords.com, http://www.investorwords.com/4299/risk_free_return.html 3 Investopedia.com, http://www.investopedia.com/terms/r/risk‐freerate.asp

40

2. COEFFICIENT OF VARIATION – CV The coefficient of variation (CV) gives you a risk-to-return ratio, i.e., units of risk per unit of return that can be used to compare mutual fund performance on a level basis1. It is calculated as:

′

When comparing two assets (funds), it is sometimes helpful to use the coefficient of variation (CV), which is the standard deviation divided by the mean, thus normalizing the standard deviation and facilitating the comparison of assets (funds) on a risk-to-return basis. This works well period-by-period but, because actual returns include the risk-free rate, which varies over time, it is not appropriate for period-to-period comparison2. Funds 2006 2007 2008

Returns Std. Dev.

CV Returns Std. Dev.

CV Returns Std. Dev.

CV

Money Market / Fixed-Income Funds (Annualized)

DMMF 11.20

2.46

0.22

10.65

4.90

0.46

9.62

1.51

0.16

PIF 9.68

2.49

0.26

10.21

0.99

0.10

8.83

0.72

0.08

UMMF 8.99

0.98

0.11

9.81

0.77

0.08

8.87

0.52

0.06

UTPIF 10.87

1.97

0.18

9.73

0.74

0.08

9.16

0.59

0.06

AIF 10.94

1.76

0.16

9.79

3.01

0.31

9.05

0.56

0.06

Stock Funds (Absolute)

NIT 2.28

6.17

2.71

3.24

4.78

1.48

(0.39)

6.40

(16.34)

PSM 2.35

4.81

2.04

2.32

4.68

2.02

(0.04)

6.72

(149.89)

ASMF 2.49

5.03

2.02

2.66

4.86

1.83

(0.34)

7.09

(20.60)

CDF 1.40

6.12

4.38

4.51

9.38

2.08

3.08

10.77

3.49

Table 13: FMRs and DCM Research

1 Your Complete Guide to Investing in Mutual Funds, http://www.investing‐in‐mutual‐funds.com/mutual‐

fund‐performance.html 2 Ibid, http://www.investing‐in‐mutual‐funds.com/investment‐risk.html

41

The above statistics show that the money market / fixed-income funds have less CV than stock funds. This proves that stock funds are highly risky and conversely provide high returns as well.

3. SHARPE RATIO Developed by William Forsyth Sharpe in 1966. Sharpe originally called it the "reward-to-variability" ratio before it began being called the Sharpe Ratio by later academics and financial professionals1. He introduced the concept of risk-free asset (rate)2. It is one of the oldest risk measurement ratios. Recently, the (original) Sharpe ratio has often been challenged with regard to its appropriateness as a fund performance measure during evaluation periods of declining markets3. Sharpe introduced following reward to variability ratio:

Numerator in the formula referred to as Excess Return. It is a very useful measure of performance that is especially relevant when comparing mutual funds within a category4. It is based on historical data. The higher the Sharpe Ratio, the better is the performance. The Sharpe Ratio is a measure of excess return per unit of total risk5. The portfolio offering the highest reward/risk ratio then is the only risky portfolio in which investors will choose to invest. Using average returns of the portfolio uses Sharpe ratio to measure ex-post portfolio performance6.

1 Wikipedia.org, http://en.wikipedia.org/wiki/Sharpe_ratio 2 Shah, S.M. Aamir and Hijazi, Syed Tahir, “Performance Evaluation of Mutual Funds in Pakistan”, in The

Pakistan Development Review 44:4 Part II, Winter 2005, p. 868. 3 Ibid. 4 Your Complete Guide to Investing in Mutual Funds, http://www.investing‐in‐mutual‐funds.com/mutual‐

fund‐performance.html 5 Ibid. 6 Shah, S.M. Aamir and Hijazi, Syed Tahir, op. cit., p. 869.

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Below performance table once again confirms the high volatility of stock based mutual funds with negative values of Sharpe Ratio. The negative ratios indicate the inability of the fund managers in diversification. Sharpe Ratios Funds 2006 2007 2008 Money Market / Fixed-Income Funds DMMF 1.28 0.41 0.03 PIF 0.66 1.61 (1.06)UMMF 0.97 1.54 (1.36)UTPIF 1.43 1.50 (0.71)AIF 1.64 0.39 (0.95)Stock Funds NIT (1.23) (1.47) (1.78)PSM (1.56) (1.69) (1.64)ASMF (1.46) (1.56) (1.60)CDF (1.38) (0.61) (0.74)Table 14: FMRs and DCM Research

The ratio was also used by rating agencies for scoring mutual funds. For example, Pakistan Credit Rating Agency (PACRA) and Japan Credit Rating Agency – Vital Information Services (JCR-VIS), rating agencies of scoring mutual funds in Pakistan, were giving star ratings to mutual funds on the basis of Sharpe Ratio and similar calculations. After June 2008, due to current financial crisis, the criteria have changed and still no proper disclosure has been made by any of the rating agency.

Limitation The Sharpe ratio has as its principal advantage that it is directly computable from any observed series of returns without need for additional information surrounding the source of profitability. Unfortunately, some authors are carelessly drawn to refer to the ratio as giving the level of risk adjusted returns when the ratio gives only the volatility of adjusted returns when interpreted properly.

4. TREYNOR RATIO Introduced by Jack Treynor. He introduced two types of risk, Systematic and Specific (as mentioned earlier). It is the measure of the excess return per unit of systematic risk. It is sometimes called as reward to volatility ratio. Similarly funds having high ratio, means that it has more excess return per unit of systematic risk

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and should be preferred. Treynor ratio uses Beta as a risk measure hence considers the Systematic risk. This ratio also measures the portfolio manager’s ability on the basis of rate of return performance and diversification by taking into account systemic risk of the portfolio1. Treynor proposed the following model:

This model is usually used for stock funds because of the involvement of beta which is the measure of volatility of stock funds. It was also used as a ranking criterion along with the Sharpe Ratio. The systematic risk of the data of the Pakistani stock mutual funds is given below. Negative values of Treynor Ratio indicates the inability of the fund manager for diversification. The beta of all funds in all years is less than one. If the diversifiable risk which is company specific is fully diversified away by the funds portfolio manager, the results of Sharpe ratio and Treynor ratio are same. Our funds are facing the diversification problem that is why the results of both ratios are not the same2. Stock Funds

Funds 2006 2007 2008

Beta Treynor Beta Treynor Beta Treynor NIT 0.70 (10.88) 0.56 (12.43) 0.71 (15.96)PSM 0.25 (29.82) 0.65 (12.22) 0.73 (15.14)ASMF 0.63 (11.76) 0.71 (10.73) 0.80 (14.15)

CDF 0.40 (21.13) 0.96 (5.99) 1.12 (7.06)

Table 15: FMRs and DCM Research

Limitation Like the Sharpe ratio, the Treynor ratio does not quantify the value added, if any, of active portfolio management. It is a ranking criterion only. A ranking of portfolios based on the Treynor Ratio is only useful if the portfolios under consideration are sub-portfolios of a broader, fully diversified portfolio. If this is

1 Shah, S.M. Aamir and Hijazi, Syed Tahir, “Performance Evaluation of Mutual Funds in Pakistan”, in The

Pakistan Development Review 44:4 Part II, Winter 2005, p. 870. 2 Shah, S.M. Aamir and Hijazi, Syed Tahir, op. cit., p. 871.

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not the case, portfolios with identical systematic risk, but different total risk, will be rated the same. But the portfolio with a higher total risk is less diversified and therefore has a higher unsystematic risk which is not priced in the market1.

5. JENSEN’S ALPHA Another ranking criterion, developed by Michael Jensen in the 19692, also known as Jensen's Performance Index or ex-post alpha or Jensen’s Differential Measure, is used to determine the excess return of a security or portfolio of securities over the security's theoretical expected return. It is an index that uses the CAPM (Capital Asset Pricing Model) to determine whether a money manager outperformed a market index3. The basic idea is that to analyze the performance of an investment manager you must look not only at the overall return of a portfolio, but also at the risk of that portfolio. For example, if there are two mutual funds that both have a 12% return, a rational investor will want the fund that is less risky. Jensen's measure is one of the ways to help determine if a portfolio is earning the proper return for its level of risk. If the value is positive, then the portfolio is earning excess returns. In other words, a positive value for Jensen's alpha means a fund manager has "beat the market" with his or her stock picking skills4. Jensen introduced alpha in the capital asset pricing model to measure the abnormal return of a portfolio—that is difference between the actual average return earned by a portfolio and the return that should have been earned by the portfolio given the market conditions and the risk of the portfolio5. Jensen measure is calculated as follows:

′

1 Wikiepedia.org, http://en.wikipedia.org/wiki/Treynor_ratio#column‐one 2 Shah, S.M. Aamir and Hijazi, Syed Tahir, “Performance Evaluation of Mutual Funds in Pakistan”, in The

Pakistan Development Review 44:4 Part II, Winter 2005, p. 871. 3 Investorwords.com, http://www.investorwords.com/2658/Jensen_index.html 4 Investopedia.com, http://www.investopedia.com/terms/j/jensensmeasure.asp 5 Shah, S.M. Aamir and Hijazi, Syed Tahir, Syed Tahir, op. cit, p. 871.

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This measure is also for stock funds due to the involvement of beta. The alpha figures of Pakistani stock based mutual funds are as follows: Stock Funds Funds 2006 2007 2008 NIT 1.63 18.99 (2.27)PSM 10.92 1.22 1.88 ASMF 6.50 (0.41) (0.38)CDF (4.44) 25.79 48.52 Table 16: FMRs and DCM Research

Positive alpha of the mutual funds is an indication that the funds outperform the market proxy—KSE 100 index, and vice versa in terms of negative alpha. Many academics believe financial markets are too efficient to allow for repeatedly earning positive Alpha, unless by chance. To the contrary, empirical studies of mutual funds spearheaded by Russ Wermers usually confirm managers' stock-picking talent, finding positive Alpha. However, they also show that after fees and expenses are deducted, the effective Alpha for investors is negative1. Nevertheless, Alpha is still widely used to evaluate mutual fund and portfolio manager performance, often in conjunction with the Sharpe ratio and the Treynor ratio.

6. INFORMATION RATIO – IR A ratio of portfolio returns above the returns of a benchmark (usually an index) to the volatility of those returns. The information ratio (IR) measures a portfolio manager's ability to generate excess returns relative to a benchmark, but also attempts to identify the consistency of the investor. This ratio will identify if a manager has beaten the benchmark by a lot in a few months or a little every month. The higher the IR the more consistent a manager is and consistency is an ideal trait2. 1 Wikipedia.org, http://en.wikipedia.org/wiki/Jensen%27s_alpha 2 Investopeida.com, http://www.investopedia.com/terms/i/informationratio.asp

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It is calculated as:

Tracking Error: It is the standard deviation of the active returns. The information ratio is similar to the Sharpe ratio but, whereas the Sharpe ratio compares the excess return of an asset against the return of a risk free asset, the information ratio compares active return to the most relevant benchmark index. That is to say, the Sharpe ratio equals the information ratio where the benchmark is a risk-free asset (e.g. cash or government bonds)1. The information ratios of Pakistani mutual funds are: Funds 2006 2007 2008

Money Market / Fixed-Income Funds DMMF 0.86 0.06 (0.55)PIF 0.19 (0.17) (1.23)UMMF (0.23) (0.68) (1.64)JSIF 0.81 (0.88) (1.65)AIF 1.06 (0.18) (1.60)Stock Funds NIT (0.12) 0.10 0.21 PSM (0.05) (0.21) 0.21 ASMF (0.07) (0.11) 0.18 CDF (0.20) 0.24 0.76 Table 17: FMRs and DCM Research

In the above performance table, both stock and money market / fixed-income funds are showing negative IR values indicating problems with prudency in fund management and diversification. Especially in 2008, all money market / fixed-income funds are under performed but stock fund managers did the excellent job in getting positive IR values despite the market crash due to financial crisis.

1 Wikipedia.org, http://en.wikipedia.org/wiki/Information_ratio

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D. NON-QUANTITATIVE RISK ASSESSMENTS In addition to the quantitative assessment, few non-quantitative approaches have also been identified. Investment Company Institute in its journal, Perspective, Volume 1, Number 2, November 1995, identified following assessments:

1. SELF-ASSESSMENT OF RISK Many fund sponsors include in sales literature a ranking of the relative risks of the funds within their complex. In general, such measures assist comparison of different types of funds. For instance, a fund complex may provide a “risk spectrum,” with a money market fund at the low end and an aggressive growth fund at the high end. Such rankings, however, appear inappropriate as mandated prospectus disclosure. Requiring such self-assessment would raise serious liability concerns. For example, a fund categorized as “low risk” could incur liability if an unforeseen market event, such as a significant devaluation of a foreign currency, caused a precipitous decline of net asset value. (As a result, few funds would feel comfortable labeling themselves as “low risk.”) Instead, funds would likely feel compelled, out of liability concerns, to include considerable narrative describing the risk scale and the basis for assessment. Such disclosure runs counter to the general SEC objective of prospectus simplification. Also, subjective self-assessments, many of which are fairly broad risk categories such as low, medium, and high, would prove useless to investors comparing funds from different sponsors (e.g., comparing one money market fund with another).

2. RISK MANAGEMENT PROCEDURES To the extent risk management procedures are deemed material to an investment decision, they should be, and generally are, fully disclosed. Otherwise, we question their relevance to investors. And a detailed discussion of technical aspects of portfolio investing will merely lengthen fund prospectuses, with no corresponding investor benefit. Most investors are not likely to

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understand procedures such as “stress testing,” or their relevance. In addition, funds could be forced to disclose proprietary information. Finally, and perhaps most important, it could be implied that such disclosure seeks to eliminate all risks, clearly not the case and emphatically not consistent with the concept of investing in securities. There are many other factors to consider when analyzing a mutual fund's portfolio. By analyzing the sector weights of a fund and the fund manager's attributions to performance, an investor can better understand the historical performance of the fund and how it should be used within a diversified portfolio of other funds. An investor can also break down the portfolio into market cap groupings and determine whether the fund manager is particularly skilled at picking companies with certain size characteristics. Many investors tend to focus exclusively on investment return, with little concern for investment risk. The risk measures just discussed can provide some balance to the risk-return equation. The good news for investors is that these indicators are calculated for them and are available on several financial websites, as well as being incorporated into many investment research reports. As useful as these measurements are, keep in mind that when considering a mutual fund investment, volatility risk is just one of the factors you should be considering that can affect the quality of an investment.

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CHAPTER III

SUMMARY

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CONCLUSION

From the review, it has been concluded that mutual funds are the important

source of investment for both the households and institutions. The key factor is to

decide the mutual funds on the basis of one’s risk tolerance. The review provides

certain yardsticks to gauge the mutual funds giving examples of Pakistani mutual

funds performance on these yardsticks to help understand the readers the basic

concept of risk and reward trade-offs.

The methods explained above to measure the performance of mutual funds

under risk and return perspective, are all historically based. Despite this,

however, investors may unduly rely on them as predictive of future risk or

performance, or even promissory in nature – despite disclosure to the contrary.

As a result, investors may not understand that a fund could behave very

differently because of changes in market conditions (e.g., changes in interest or

foreign exchange rates) or portfolio holdings.

“Several measures are being used to describe mutual funds’ riskiness. Most are

complex, none is perfect, and all have the potential to mislead…”1 Russ Wiles, Los Angeles Times

The risk and return understanding and quantitative measurement of risk on

investment related to its return (or benchmark) is still in a process of

development in our country. A layman investor is still unaware of the

performance measurement yardsticks of the investment like mutual fund which is

the most common vehicle of investment throughout the world. Unfortunately,

evidence exists that many investors already may be making investment decisions

ill advisedly. It would be deeply disturbing to further aggravate this alarming

trend. Also reliance on a single, numerical measure of risk may cause investors

to make the wrong investment decisions.

1 Perspective, Investment Company Institute, Volume 1, Number 2, November 1995, p. 10.

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“I worry that, by focusing exclusively on the riskiness of each individual fund, the

SEC may scare investors into sticking with more conservative investments.”1 Jonathan Clements, The Wall Street Journal

Similarly, the risk of any particular investment needs to be considered in light of

the other elements of an investor’s portfolio. Many mutual fund sponsors,

investment advisers, personal finance columnists, and others have long stressed

the importance of evaluating investments within the context of one’s overall

portfolio.11 Even assuming the appropriateness of short-term volatility (as

measured by standard deviation) as a risk measure, one cannot be sure of any

one investment’s effect on the overall volatility of an investor’s portfolio (which

from an investor’s perspective would be the more relevant consideration).

As discussed above, investors in our country only look at the return side of the

investments and completely ignores the risk assessment side, which is

dangerous. Current financial crisis is, in one way, the result of improper risk

management. Now financial institutions along with the regulator have

emphasized of having risk manager in every institution including Asset

Management Company in particular to advice fund managers on risk-to-return

trade-offs on each investments in a portfolio.

Mutual Funds Industry in Pakistan is at present set to takeoff to new heights. But

to achieve this, concerted and sustained efforts are required both from the

stakeholders and the regulators. At present, they are playing their due role for the

growth and development of the industry. The government is taking a series of

measures to provide the necessary conducive working environment whereas the

stakeholders/operators of the industry are striving hard to create the requisite

awareness about the mutual funds among the masses through media, training

programs etc. and also by developing their reputation and maintaining good

1 Perspective, Investment Company Institute, Volume 1, Number 2, November 1995, p. 8.

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records. If these efforts are made on regular basis, it is hoped that the mutual

funds industry in Pakistan will be able to achieve the desired results in medium to

long term.

RECOMMENDATIONS

Current financial crisis has shaken the investors’ confidence from the capital

markets which had adversely affected the mutual funds industry in Pakistan. Now

there is a dire need from the regulator and association to come forward along

with AMCs to play their due role in the development of this industry.

The steps taken by participators of the industry seem inadequate to restore the

investors’ confidence. In fact, their measures (including freeze of stock market

and equity funds) engendered confusion.

This industry had a very successful period during 2006 and 2007. They were

managing all time high assets under management and giving handsome returns

beating their respective benchmarks. But now the situation is changed. The

assets under management are dropped to more than half. It is true that the

values are bottomed out but at the same time the probability of a rebound is also

reasonably high.

The participants should take certain steps to more educate the investors

especially retail and households and provide awareness about their investment

products especially risk to reward trade-offs, through advertisements, media,

training programs etc. as it is observed that funds focusing on retail clientele

emerged stronger. They should strive hard to provide more conducive

environment to the investors.

The size of the mutual funds sector in Pakistan is still very small as compared to

developed counties and even India. The sector cannot be strengthened without

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broadening retail investor base. This objective is hard to achieve without

attracting small investors, extending outreach and ensuring uninterrupted

redemption and sales. This can only be done through large scale education of

households regarding investments avenues and need of savings and

investments. Proper risk disclosure should also be provided so that every

household be able to decide on his or her risk tolerance.

While selling the code of ethics should not be ignored. Misrepresentation by a

sales agent is also a major reason for this set back. They should provide realistic

information to investors regarding the risk profile of the mutual funds so that the

Code of Ethics for Investments is not violated.

Currently there is a lack of investments avenues, therefore, AMCs have to invest

in long term illiquid investments creating a highly risky environment for investors

as well as for funds. Fund manager should maintain a balance between long

term and short term investment by keeping the funds risk profile in mind.

Regulator and association with collaboration with investment companies should

provide enough invest avenues in the market to cater the increasing needs of the

investments. At the same time AMCs should concentrate on their strategies to

bring more and more retail investors to the industry.

The need is to develop a confidence of households and also institutions in these

investments products. Investing small savings of households in a huge pool of

investment baskets, with the support of institutional investments, our economy

may able to post success stories like west.

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BIBLIOGRAPHY

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1. Rao, P. Hanumantha and Mishra, Vijay Kr., “Mutual Fund: A Resource Mobilizer in Financial Market”, in Vidyasagar University Journal of Commerce, Vol. 12, March 2007.

2. Invest Wisely: An Introduction to Mutual Fund, U.S. Securities and

Exchange Commission, http://www.sec.gov/investor/pubs/inwsmf.htm.

3. Jones, Charles P. (2005-06), Investments Analysis and Management, 10th edition, California.

4. Aamir Shah, S.M. and Hijazi, Syed Tahir, “Performance Evaluation of Mutual Funds in Pakistan”, in The Pakistan Development Review 44:4 Part II, Winter 2005.

5. 2009, Investment Company Fact Book, 49th Edition, A Review of Trends and Activity in the Investment Company Industry

6. Perspective, Investment Company Institute, Volume 1, Number 2,

November 1995

7. MUFAP Sources, www.mufap.com.pk

8. MUFAP, Country Report Pakistan 2007.

9. Your Complete Guide to investing in Mutual Funds, http://www.investing-in-mutual-funds.com/risk-and-return.html#investment

10. Your Complete Guide to Investing in Mutual funds, http://www.investing-in-mutual-funds.com/mutual-fund-risk.html

11. Your Complete Guide to Investing in Mutual funds, http://www.investing-in-mutual-funds.com/screening-mutual-funds.html

12. Your Complete Guide to Investing in Mutual Funds, http://www.investing-in-mutual-funds.com/mutual-funds-glossary.html#riskfree

13. Your Complete Guide to Investing in Mutual Funds, http://www.investing-in-mutual-funds.com/mutual-fund-performance.html

14. The Financial Planning Center, Mutual Fund Risk, http://www.open-ira.com/Education_Center/3c_Mutual_Fund_Risk.htm

15. Investorwords.com, http://www.investorwords.com/4688/standard_deviation.html

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16. Investorwords.com, http://www.investorwords.com/4299/risk_free_return.html

17. Investorwords.com, http://www.investorwords.com/2658/Jensen_index.html

18. Investopedia.com, http://www.investopedia.com/terms/r/r-squared.asp

19. Investopedia.com, http://www.investopedia.com/terms/r/risk-freerate.asp

20. Investopedia.com, http://www.investopedia.com/terms/j/jensensmeasure.asp

21. Investopeida.com, http://www.investopedia.com/terms/i/informationratio.asp

22. Wikipedia.org, http://en.wikipedia.org/wiki/Sharpe_ratio

23. Wikiepedia.org, http://en.wikipedia.org/wiki/Treynor_ratio#column-one

24. Wikipedia.org, http://en.wikipedia.org/wiki/Jensen%27s_alpha

25. Wikipedia.org, http://en.wikipedia.org/wiki/Information_ratio

26. Morningstar.com, http://www.morningstar.com/invglossary/r_squared_definition_what_is.aspx

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ABBREVIATIONS

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AAML Atlas Asset Management Limited AHIML Arif Habib Investments Management Ltd AHIML Arif Habib Investments Management Limited AIF Atlas Income Fund AMC Asset Management Company ASMF Atlas Stock Market Fund CAM Crosby Asset Management CAPM Capital Assets Pricing Model CDF Crosby Dragon Fund CV Coefficient of Variation DCM Dawood Capital Management Limited DMMF Dawood Money Market Fund IR Information Ratio JSIF JS Income Fund JSIL JS Investments Limited MUFAP Mutual Funds Association Of Pakistan NIT National Investment Trust PIF Pakistan Income Fund PSM Pakistan Stock Market Fund RAR Risk-Adjusted Return RF Risk-Free Interest Rate SEC Securities And Exchange Commission SECP Securities And Exchange Commission of Pakistan T-Bill Treasury Bill UBLFM UBL Fund Managers UMMF United Money Market Fund

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APPENDICES

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Money Market / Fixed-Income Funds Monthly Returns Summary for 36 months from Jul-2005 to Jun-2008 Monthly Return Summary 2005-2006 Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 6M KIBOR 8.90 8.93 8.90 9.02 9.14 9.14 9.14 9.25 9.34 9.49 9.67 10.03 3M T-Billk 7.62 7.86 8.10 8.10 8.10 8.09 8.10 8.10 8.10 8.10 8.10 8.29 DMMF 7.54 7.16 10.86 9.30 12.09 15.33 10.93 11.37 12.86 11.66 10.63 14.64 PIF 4.70 6.33 7.22 12.05 9.24 9.56 12.64 11.13 12.62 10.42 9.99 10.24 UMMF 8.29 8.07 8.13 8.96 9.26 9.36 10.37 9.66 9.67 9.77 9.54 6.84 UTPIF 7.14 8.61 14.62 12.47 10.96 11.59 11.96 11.45 8.97 10.36 11.89 10.41 AIF 6.80 9.78 11.03 10.88 10.27 10.98 12.47 12.39 12.51 10.19 10.34 13.68

Monthly Return Summary 2006-2007 Jul-06 Aug-06 Sep-06 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07

6M KIBOR 9.92 10.42 10.37 10.51 10.56 10.61 10.55 10.49 10.43 10.25 10.17 10.03 3M T-Bill 8.32 8.63 8.64 8.64 8.64 8.64 8.64 8.64 8.65 8.69 8.69 8.69 DMMF 6.95 11.00 11.55 9.67 9.52 21.99 1.29 11.37 13.67 6.69 11.03 13.12 PIF 8.22 9.57 10.05 10.56 11.99 10.81 10.27 10.78 11.19 9.44 9.28 10.40 UMMF 10.57 9.41 8.77 9.84 10.55 10.81 10.19 9.77 9.00 9.35 8.69 10.76 UTPIF 9.30 9.09 10.22 8.72 9.85 10.64 10.17 10.58 9.48 10.54 8.40 9.83 AIF 9.98 10.20 9.87 9.41 9.08 8.68 8.05 8.54 8.41 7.02 9.31 18.91

Monthly Return Summary 2007-08 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08

6M KIBOR 9.97 10.13 10.01 10.00 9.97 9.97 10.05 10.28 10.32 10.37 11.46 13.32 3M T-Bill 8.69 8.69 8.69 8.69 8.69 8.69 8.69 8.69 8.69 8.69 8.69 8.69 DMMF 9.72 9.64 8.22 9.97 10.15 8.97 10.03 10.57 10.64 12.12 9.51 5.90 PIF 8.91 10.47 8.82 8.70 7.99 9.26 7.84 8.80 9.50 8.93 8.12 8.57 UMMF 8.98 9.13 8.83 8.87 8.31 8.85 9.52 8.45 8.41 9.29 7.98 9.80 JS-IF 9.52 9.23 8.90 9.62 8.53 8.18 9.68 8.61 8.98 9.10 9.20 10.38 AIF 8.57 8.53 9.92 8.65 9.07 8.39 9.54 8.38 9.41 9.16 9.12 9.89

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Stock Funds Monthly Returns Summary for 36 months from Jul-2005 to Jun-2008 Monthly Return Summary 2005-06

Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 KSE (3.65) 8.64 5.47 0.26 9.45 5.86 10.13 8.86 0.26 (1.25) (13.59) 1.93 10Y PIB 7.13 7.13 7.13 7.13 7.13 7.13 7.13 7.13 7.13 7.13 9.85 9.85 NIT (0.21) 4.39 9.94 4.29 9.89 4.15 9.42 0.62 (1.32) (2.95) (11.42) 0.52 PSM 0.23 7.29 7.76 4.03 5.27 6.72 0.60 1.39 (2.18) (9.12) 1.03 5.22 ASMF 1.03 3.98 6.06 2.73 6.64 2.99 9.09 6.03 1.82 (0.86) (10.67) 1.05 CDF 0.23 0.74 6.90 1.71 6.26 6.70 4.84 0.65 4.50 (15.21) (3.76) 3.20 Monthly Return Summary 2006-2007

Jul-06 Aug-06 Sep-06 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 KSE 5.09 (4.14) 4.46 7.75 (6.25) (5.45) 12.27 (0.82) 0.82 9.74 4.78 6.26 10Y PIB 9.85 9.85 9.85 10.39 10.39 10.51 10.51 10.51 10.15 10.13 10.13 10.11 NIT 4.71 (2.00) 5.88 (0.32) 0.75 (4.26) 8.11 (1.54) 1.98 10.24 9.01 6.27 PSM 5.22 (5.25) 2.68 3.71 (4.74) (3.39) 6.44 0.24 1.99 7.81 7.81 5.37 ASMF 4.36 (2.97) 3.64 6.69 (4.05) (4.40) 8.87 (0.21) 0.08 8.04 8.04 3.83 CDF 3.20 (9.10) 2.75 7.94 (7.69) (3.57) 6.01 5.62 0.10 8.62 16.57 23.68 Monthly Return Summary 2007-08

Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 KSE (0.24) (11.10) 9.33 7.25 (2.25) 0.56 (0.43) 6.54 1.28 (0.02) (19.78) 1.31 10Y PIB 10.11 10.34 10.34 10.20 10.20 10.20 10.78 10.78 11.43 11.43 11.43 13.41 NIT 0.30 (9.05) 8.00 8.94 (0.58) (0.17) - 4.01 1.12 (1.11) (14.30) (1.87) PSM 0.75 (9.22) 11.16 8.22 (1.55) (3.84) (1.23) 6.49 1.67 (1.17) (12.41) 0.60 ASMF (0.72) (8.60) 8.10 7.06 (1.24) (2.61) 0.91 6.72 2.13 0.58 (17.43) 0.96 CDF (2.76) (10.52) 16.02 11.83 0.71 2.24 2.33 11.52 5.70 16.90 (20.07) 3.13

MUTUAL FUNDS - RISK AND RETURN PERSPECTIVES

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