Understanding Mutual Funds
Mutual funds are often described as pooled investments which are held in trust on behalf of the individual investors. Each fund has a defined investment objective that determines the overall management of the fund and the types of investments that can be held in it. When you invest in a mutual fund, you purchase units in the fund, where each unit represents a share of the fund’s value.
A professional fund manager uses this money to buy stocks, bonds, or money market instruments that make up the fund’s portfolio of investments.
Concept
A Mutual Fund is a single portfolio of investments where investors put their money to be managed by an asset management company on behalf of its many investors. This allows each investor access to a professional managed pool of funds.
Fund Manager invests the fund’s capital in profitable avenues and attempt to earn a return for the fund’s investors. The income earned through these investments and the capital appreciation realized is shared by its unit holders in proportion to the number of units owned by them.
The figure below describes broadly the working of a mutual fund:
Benefits of Mutual Funds
Mutual fund investing offers important advantages especially for individuals who prefer not to be involved directly in the hectic and time consuming process of studying companies and then placing execution orders with brokers tracking price moment of stock.
Professional Management
With Mutual Funds, a team of experienced and skilled professionals is responsible for the investment decision making. Team consists of dedicated fund management and investment research team which analyze the performance and prospects of companies and selects suitable investments to achieve the objectives of the fund. ABL Funds has an experienced team of portfolio managers from diverse backgrounds with varying expertise and skills.
Diversification
One of the most important benefits of mutual funds is Diversification as it reduces investment risk of concentration. In simple terms it can be explained through below phrase: Do Not Put All the Eggs in One Basket.
Mutual funds in general can hold many different investments across a broad cross-section of industries and sectors, offering a level of diversification often only achieved with larger portfolios. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. Because of diverse range, the ups and downs of any one security have less effect on the fund’s overall performance. However, though diversification can help reduce the risk and enhance the stability of investment, it does not guarantee loss prevention.
Liquidity
Liquidity simply means being able to access your money when you need it. Mutual funds are considered liquid investments because you can usually redeem your units as the need arises and have your money as per the time limits prescribed in the offering document of the fund. With mutual funds you can buy and sell units easily, move money among different funds, and redeem.
Affordability
As a small investor, you may find that it is not possible to buy shares of companies with high share price. Such companies have low share base and high profits as a result investors allocate them higher price. Mutual funds access to pool funds allows buying securities in market in every price category. Through mutual funds investors can enjoy a diversified portfolio by investing as low as Rs 5,000.
Tax Credit Benefits
To induce saving habits in general public, Government of Pakistan has given incentive to investor in form of tax rebate. An investor can claim tax credit by investing in mutual funds and reducing his tax liability to government. Read more for a better understanding of the Tax Credit Benefit
Convenience
Mutual funds are easy to purchase. Investors can simply match their risk tolerance, objectives and time line to an appropriate mutual fund. Professional fund managers do all the work on your behalf and monitor your investment on minute to minute basis. Being expert in their area, they are also better equipped to make decision on timely basis.
Return Potential
Owing to their expertise in investment decision making and accessibility of dedicated resources, Mutual Funds have the potential to provide a higher return in medium to long term. As described earlier, Mutual funds also have advantage of diversification which reflects in better returns in long term.
Transparent and Well Regulated
Mutual funds are stringently watched by regulators, settlement house (stock exchange), trustee, auditors and Shariah auditor (Islamic Funds) also. Multiple levels oversee and audit builds trust of investor as it makes investment process very transparent.
All Mutual Funds are registered with SECP and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SECP. In addition to that, mutual funds assets are placed with trustee to further ensure investors asset protection.
Shariah compliant mutual funds’ operations are oversight by a renowned Shariah Advisor to ensure the compliance with the Shariah guidelines. Learn more about our Shariah Advisors’ Philosophy and Shariah Methodology
In addition to this, the Fund also prepares and discloses periodic financial statements, which provide an in-depth review of all the major activities undertaken by the fund over the period.
Fexibility
Mutual Funds provide various value added services which makes it very easy for investors to manage and track their investments. They can even invest or redeem in mutual fund by just sitting at home through online transactions. Learn more about Value Added Services provided by ABL Funds
Choice of Schemes and Plans
Mutual Funds offer a variety of product schemes to suit your varying needs and financial goals. Goal based plans are also offered such as Systematic Investment Plans (SIP) and Savings Plans which are convenient for investors to invest and achieve their long term objectives such as kids’ education or marriage.
How to Select a Mutual Fund
Before investing in a mutual fund, you should consider following key factors. You should carefully read the Offering Document to ensure that you understand exactly what you are investing in.
| Factors | Importance |
|---|---|
| Identify your Investment goals | Before you invest, you need to ask yourself what you want to accomplish. For short-medium term goals, different products shall be selected like Fixed Income or money market funds. For long terms goals and for capital appreciation, equity fuds shall be selected. Explore more to determine your investment profile |
| Know your Time Frame/Investment Horizon | How much time is available till you need access to the money invested is a very important factor to consider. By dividing your goals into long- and short-term, you’ll make selecting the right investments a lot easier:
|
| Choose a mutual fund that suits your investment objective. | Broadly, there are three investment objectives of mutual fuds: Capital Appreciation, Income and Protection. Learn more about how to select the right investment option. |
| Understand the Level and Type of Risk involved | Every investment involves some degree of risk. You have to decide how you feel about risk? Generally Mutual Funds’ Offering Documents contain information about the types of risk that investors are exposed to. Like any other market linked investment, mutual funds too are subject to price fluctuation, liquidity, credit risks, etc. Mutual funds however, minimize these risks through diversification and professional management. Performance of mutual funds is dependent on the investments in the portfolio. It is highly encouraged to carefully read, comprehend and make an informed decision according to one’s ability and willingness for the risk. The main thing is that you find a comfortable balance between potential risk and potential earnings |
| Understand the costs involved | The mutual funds incur certain recurring expenses for managing the scheme which is charged to the scheme. Some of these expenses are:
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Types of Mutual Funds
Wide varieties of Mutual Fund exist to cater to varying individual needs and differing circumstances and profile.
By Structure
Open End Mutual Fund
These funds continually create new units or redeem existing units on demand. The unit holders buy the units of the fund or may redeem them on a continuous basis at the prevailing Net Asset Value (NAV). The investor needs to contact the Asset Management Company and the AMC will facilitate in the particular transaction.
Close Ended Mutual Fund
Closed-end funds have a fixed number of shares outstanding and do not redeem when investors want to sell; instead, the shares trade in the secondary markets (stock markets). Its market price is determined by demand and supply and is not directly tied to its net asset value. In order to buy or sell units of a close ended Mutual Fund, the investor shall need to contact the broker and not the AMC.
| Open End Fund | Close End Fund |
|---|---|
| You can invest or redeem whenever you like | You can buy/ sell units in the stock market |
| Investment and Redemption is very convenient, you can simply contact the Asset Management Company | To buy/ sell units you need to contact your broker |
| NAV of fund is available at the end of business day. | The price of the unit is available of the stock market |
By Investment Objectives
Mutual funds can be grouped roughly into following categories according to investment objective.
| Fund Category | Objective | Risk | Types of Investments |
|---|---|---|---|
| Equity Funds | Long-term growth of capital by investing in stocks. | Equity funds may exhibit short-term fluctuation and therefore carry a higher level of risk. Investors need to be prepared to tolerate this higher risk. Equity funds could be a good investment if you have a long-term perspective and can stay invested for at least three years or perhaps even longer. | Primarily invest in stocks of companies as per the investment objective and philosophy. |
| Balanced Funds | To generate long term capital appreciation as well as current income from a portfolio comprising of both equity as well as fixed income securities. | Balanced funds which have a combination of both equity and fixed income instruments, tend to provide investors with a moderate level of risk exposure. Balanced funds are ideal for those looking for income and growth over medium to long-term investment horizon. | Balanced funds primarily invest in equities as well as in fixed income instruments. |
| Index Tracker Funds | To provide investors an opportunity to track closely the performance of an Index by investing in proportion to the constituent securities found in the index. Being a passive fund, it charges lower management fee from unit holders vs. a pure equity active fund. | The Fund is suitable for investors who may simply wish to mirror the risk and return profile that is achieved by investing in any particular index. It must be noted that these are risky investments, since the underlying securities are usually equity securities with their inherent volatility intact. However, the fund manager has no discretion on the choice of security, other than to passively invest in the constituent equity securities in the weightages, as found in the subject index. | Index funds are 100% replica of a particular index. |
| Income Funds |
To have a regular stream of income by investing in debt securities that have the potential to provide a higher level of regular income than money market funds and may also generate reasonable capital growth. |
Fixed income funds are usually safer investment avenues than stock funds, but maybe slightly more riskier than money market funds. As is the case with other Fixed Income securities, their prices and performance is heavily dependent on the level and change in interest rates (and other market conditions). These are usually suitable for investors who want to avoid the high volatility experienced in the stock market. |
Fixed income funds primarily invests in Govt. Securities, Banks, Sukuks, TFC, TDR, CFS, Certificate of Musharka, Spread Transactions etc |
| Money Market Funds |
These funds aim to preserve your original investment and achieve target returns with high certainty and low risk factor by investing in investment instrument with low risk and lower volatility. |
Money market funds are considered fairly safe and appropriate for investors who want to limit risk or who are investing for a short period of time and want ready access to their money. Money market funds have very low risk of losses in principal invested along with higher certainty of target return achievement. |
Money Market funds primarily invests in highly rated Govt. Securities, Banks, Sukuks, TFC, TDR, CFS, Certificate of Musharka, etc |
| Asset Allocation Funds | Tho generate returns by investing in a mix of equity and debt securities (or any other asset class that may be included as well). | Asset allocation funds are suitable for investors who have the comfort on the fund manager to prudently switch between the various asset classes, as per market outlook. | Asset Allocation funds usually shift their exposures between debt and equity (and/or any other asset class) as per the outlook on the market. |
| Capital Protected Funds | To protect Initial Investment Value along with the prospect of growth upon the initial investment over the stipulated time period. | Capital protected funds are suitable for investors who do not wish to take any significant risk and are seeking the potential for improved returns above those available on money market/debt funds or bank deposits. They seek participation to equity markets with the assurance that their initial principal is protected or safeguarded.. Feature of capital protection is normally offered if the investment is held till maturity. | Capital protected funds give you 100% capital protection, with the potential to earn a return that is better than that being offered by bank deposits or money market funds/ instruments. In order to achieve their objective they may seek to cash-in on any stock market upside that may be witnessed during the tenure. |
| Voluntary Pension Schemes | To provide participants a regular income at the time of retirement and at an age when one’s capacity to work is diminished, so that one is not dependent on other members of the society. | Voluntary Pension schemes in Pakistan normally have 3 sub- funds and based on these sub-funds offer various attractive allocation schemes. Each scheme may carry a varying level of risk. For a participant investment risk range from low to high (depends on the chosen asset allocation). |
Investor can choose from a wide range of investment options depending on retirement goals, age and appetite for risk. Contributions will be invested in the particular scheme |
Mutual Funds Operations and Returns
Operations
Mutual fund schemes adheres to a specific investment objective while investing the money collected from investors as prescribed in the Offering Document. The investor is allotted units for the investment amount depending on the prevailing applicable NAV of the fund. The fund manager, depending on the investment objective of the scheme, decides the portfolio allocation.
The value of each unit of the fund called the Net Asset Value (NAV) of the fund is calculated based on the current market price of all the assets held by the fund.
The total assets held by the mutual fund at any point of time are called its Assets under Management (AUM). At launch, the AUM is equal to collective funds of all the investors. With the passage of time, funds’ are invested in securities whose value changes on daily basis reflecting in profits/losses. At the same time, new investments keep coming in, and existing investors redeem or dividend is paid to them.
Returns
Mutual fund schemes offer returns to the investors in following ways:
- Dividend and/or Coupon Income- A mutual fund may earn income in the form of dividend, or profit on the assets held in the portfolio. The income earned may be distributed by AMC to its unit holders.
- Capital Gains/Appreciation- The value of any asset or security held by a mutual fund may increase overtime. When a fund sells an asset or security at a price higher than the purchase cost, capital gains are realized by the fund. At the end of financial year, mutual funds distribute capital gains to its unit holders.
- Increased Net Asset Value- If the market value of a fund’s portfolio increases after the adjustment f expenses and liabilities it is reflected in the increased Net Asset Value of the fund. The higher the net asset value higher is the investment value.
Tracking the Performance
Periodic monitoring of the performance of the mutual fund schemes you have invested in is important as it enables you to take timely decisions in case you need to convert or exit from the fund. There are useful tools which can help you to monitor your mutual fund investments. A Fund Managers Report (FMR) is one such valuable document published by ABL Funds. It is just like a performance report card that indicates the health of the scheme by enlisting details and performance of each of the schemes managed by the AMC. It is usually published on a monthly basis and is available on the website for investors view or download. You should periodically refer to this document to keep track of your investments. you can read or download Fund Managers Report.
You can also read analysts’ reports in the media on the performance of the mutual fund scheme. There are a number of websites that offer in-depth analysis of mutual fund schemes in terms of comparable schemes, the benchmark index and average performance of all schemes in the category the scheme falls in.