Performance Evaluation of Mutual Funds in Pakistan For The Period 2004-2008

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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS
AUGUST 2010
VOL 2, NO 4
Listed in ULRICHS
Performance Evaluation of Mutual Funds in Pakistan

for the Period of 2004-2008
Akmal Shahzad
MS Scholar, Iqra University H-9, Islamabad
everbrighter2011@gmail.com
Dr. Bashir Ahmed Khilji Professor &
Head of Economic Department. National
University of Modern Languages Sector H9, Islamabad
Irfan Ahmed
Nisar Ali Asghar
Javed Ali
Abstract
Mutual funds are considered as vehicle for investment in stock market. These not only reduce the
risk but also reduce the transaction cost. Mutual performance is a common topic in all country to
be studied. This paper evaluates the mutual funds in Pakistan; provide information to different
stake holder regarding current and future developments. Simple descriptive tools employed to
intemperate data. Result shows that on overall basis, funds industry outperform the market. The
future of industry depends on the performance of funds industry and the role of regulatory bodies.
Key Words: Mutual Fund, Performance, Regularity body, Stock Market, Investment.
1.
Introduction
Mutual funds performance is one of the most commonly studied topics in investments area in the
majority countries. This is because the availability of data and importance of mutual funds as
vehicle for investment in the stock market. Mutual funds provide many benefits to their investors.
Such benefits are as follow.
COPY RIGHT 2010 Institute of Interdisciplinary Business Research
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They reduce the risk of investing in the stock market by diversification.
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Being Customer
Services that mutual funds provide such as record keeping, providing market updates, suggestions
on investment opportunities and so on. They provide professional management by experts in the
stock market. Mutual funds also reduce Transaction Costs for investors in the sense that the only
performance that investors need to see is of the fund and not the stocks or the assets held by the
fund and can easily make decisions on that basis. By pooling of investment funds, they allow
small investors to hold a diversified portfolio. The fund portfolio is also professionally managed
and monitored by professionals in the market who have both experience and information for
profitable security selection. The benefits of mutual funds mentioned above are consistent with
the ones also identified by Sipra (2006).
Mutual funds are getting much popularity around the world this is because mutual funds today
have assets under management worth not millions or billions but trillions of dollars. Mutual funds
have been in existing for a long time, U.S being the pioneer in mutual funds industry where the
growth of mutual funds started after the World War II when the mutual funds had assets worth
$1.2 billion which then reached $6 trillion by 2002 (Mahoney, 2004).
Mutual Funds provide an investment opportunity to individual investors which are professionally
managed. Mutual funds cater to the needs of especially those investors who do not have much
understanding of the financial markets, providing them with an opportunity to hold diversified
portfolios thus minimizing the overall risk of their investment
The first mutual fund introduced in Pakistan was the National Investment Trust (NIT) in 1962
which was an open-ended fund. The NIT was and is still managed by the public sector. After
NIT, the Investment Corporation of Pakistan (ICP) launched several schemes of mutual funds in
Pakistan, which were all closed-ended schemes. The ICP units were also publicly owned, but
were then privatized with the passage of time. Despite overwhelming interest in mutual funds,
they failed to catch the attention of both investors and academics in Pakistan until recently when
many privately owned funds started to be introduced by various financial institutions in Pakistan.
On the academic side, the main contributions for mutual funds came from Sipra (2006), Shah &
Hijazi (2005), Moeen & Shah (2006) and Akbar & Syed (2005).
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Observing the overall Mutual Funds Industry clearly highlights that there has been a phenomenal
growth in the Industry; both in terms of assets under management and the number of funds (Shah
& Hijazi, 2005). Shah & Hijazi (2005) indicate that total assets under management of mutual
funds including both open and closed ended funds was around (Pakistani Rupees) PKR 29 billion
which rose to PKR 112 billion in 2004. The value of assets under mutual funds management
have risen four times within a span of four year touching PKR 395 billion as of 31st March 2008
(source: Mutual Fund Association of Pakistan website). However the major contribution of this
overall industry growth came from the open ended funds which currently have assets under
management worth PKR 340 billion and the rest PKR 55 billion is held by the closed-ended
funds. The assets of open-ended funds, according to Shah & Hijazi (2005), were PKR 25 billion
in 2004 and PKR 63.86 billion in 1997. These figures show how rapidly the open-ended mutual
funds have grown.
Now, narrowing the focus to open-ended funds, by the end of June 2008 there are around sixt y
five open ended funds of various different nature. There are Islamic funds, Asset Allocation
funds, Balanced funds, pure Equity funds, Income Funds, Money Market Funds and even
recently two important categories namely fund of funds and Index Tracker funds have been
introduced. So in spite of being under developed, the Pakistani Mutual fund market has got a
wide range of funds catering to various natures of investors. All mutual funds are regulated by the
Securities & Exchange Commission of Pakistan (SECP) which is also the regulatory body for the
stock exchanges. In addition to that, most of the mutual funds have
Central Depository
Corporation (CDC) as their trustee which also takes care of stock purchase/sale taking place in
the stock exchanges. If viewed in the perspective of Product Life Cycle, then it can be said that
the Pakistani Mutual Funds industry is somewhere between the introduction and growth phase,
though the first mutual fund was launched in 1962, but the market did not start to develop and
mature the way it has recently done. Most of the funds in the market are privately owned by both
new and established Investment Companies and Asset Management Companies. However, the
oldest player in the market i.e. the National Investment Trust which still holds around one quarter
of the total assets with net assets of around PKR 104.94 billion. The stock market is an important
investment destination for equity based mutual funds around the world and so is in the case of
Pakistani Mutual Funds Industry. Karachi Stock
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Exchange (KSE) is the major and the most developed exchange of the country. It can be said that
the time when most of the mutual funds were introduced was the time when the stock market
started rising. The KSE-100 index marked an increase of 388% within a period of three years
from 2001 to 2003 and touched the 6,000 index level which was the highest KSE-100 had
touched. The index continued rising and the KSE became one of the best markets in the world.
The country attracted huge foreign investments and everything was going smooth till 2005, when
the market crashed badly after reaching the all time highest level of 10,000 points. The crash was
one of the worst (Mangi; Businessweek, 2005). Since then the stock exchange has seen various
crisis in the subsequent years while vanishing the trust of a lot of investors; both foreign and
local.
Money/bond market is another important investment destination for income/money market based
mutual funds. Unfortunately, Pakistan lacks such markets as there is no such established money
market in the country. However there are a few money market indicators like t-bills, KIBOR
(Karachi Interbank Offer Rate), Pakistan Investment Bonds (PIBs) etc but these are only
available to institutional investors and not to general public. For general public, only a few
government bonds are available and therefore there is a great need for the development of an
organized money/bond market. Lastly, it is again emphasized that the entire mutual fund industry
is at a very initial stage and the entire industry is very inexperience to reach up to the level of
other developed markets. From the above overview of the industry, it is clear that extensive
interest has been shown by both the Government and the Private sector of the country and the
performance evaluation done in the paper would tell us that by far how much the industry has
been able to accomplish its goals and we would then be able to identify the potential in the
industry.
Since the last thirty years or so, the popularity and interest in mutual funds has grown extremely
and many academics and researchers have attempted to assess performances and other related
aspects of mutual funds around the world. The objective of these researches is to provide
information for various stakeholders of this multi-billion dollar industry. In this paper the focus
has made to evaluate the performance of Pakistani Mutual Fund industry, which is relatively
newly developed and a lot of open-ended and closed funds have recently been introduced.
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2.
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Literature Review
Mutual funds, because of their popularity and the advantages they provide to investors, have
caught the attention of many academic writers. Mutual Funds are a vehicle to achieve diversified
investments both in capital and fixed income markets (Gruber, 1996). Performance evaluation is
the most studied topic in Mutual Funds because of trillions of dollars involved in them (Haslem,
2008). There have been various measures suggested to evaluate the performance of mutual funds,
important contributions coming from Sharpe (1966), Treynor (1965) and Jensen (1967). The
models then suggested became the foundation for future models. Although there has been a lot of
debate about various performance measures for mutual funds but all the models have their own
pros and cons (Grinblatt & Titman, 1993 and Fama, 1972).
Blake and Timmermann (1998) University of California, carried out a research in 1998 on
performance evaluation of UK mutual funds and found that the average UK equity fund appears
to under perform by around 1.8 percent per annum on a risk-adjusted basis. The authors says that
there is also some evidence of persistence of performance, on average, a portfolio composed of
the historically best performing quartile of mutual funds performs better in the subsequent period
than a portfolio composed of the historically worst-performing quartile of funds.
Fama & French (1993) proposed a three-factor model for mutual funds which takes into account
the fund size and book-to-market in addition to the market factor (Kothari & Warner, 1997). They
indicate that this model can be used for various purposes including portfolio selection, evaluating
performance, measuring abnormal returns and estimating the cost of capital. Kothari and Warner
(1997) argue that this model by Fama & French is better than CAPM based portfolio analysis
procedures and advocates a simple and straightforward way of carrying out any analysis.
In 2004, Otten and Bams. Economic versus statistical relevance says that the majority of US
studies conclude that actively managed portfolios, on average, under perform market indices. He
quoted the examples of the studies conducted by Jensen (1968) and Sharpe (1966). He argued
mutual funds under perform the market by the amount of expenses they charge the investors.
There are various factors that affect the performance of mutual funds. Carhart (1997) and Dellva
& Olson (1998) have attempted to research on the factors, especially on the cost sides, that affect
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the performance of mutual funds. These two researches came up with several cost side factors
with load fees, sales charges, redemption fees, transaction costs, expense ratio.
Gupta and Gupta (2001) in their studies on Indian mutual funds industry investigated that on
Septmeber 30, 1999 total assets under the management of mutual fund industry stood at Rs
85,487 crore (Rs 850 billion). Further more that the mutual fund industry has four types of
players i.e. (1) UTI; (2) public sector banks; (3) insurance corporations; and (4) private sector
funds. These four types consist of 37 players, 11 are in the public sector including UTI, and the
remaining ones are the private sector. The UTI alone accounts for Rs 63, 113 crore which is 74
percent of total assets of the industry. The share of other public sector funds is Rs 8831 crore that
is 10.2 percent of total funds in the industry. The remaining resources of Rs 13, 543 crore that is
15.8 percent are available to the private sector funds. Total number of schemes offered by all
funds is 311 out of which 182 are closed-ended; and 142 are open ended.
Another important contribution came from Jensen in 1967 who developed a model based on the
CAPM models presented by Sharpe (1964), Lintner (1965) and Treynor (undated).
Jensens (1967) model is somewhat close to that presented by Treynor (1965), as it also considers
beta for performance evaluation instead of standard deviation of returns. Jensen argued in his
model on the importance of forecasting ability of managers in performance evaluation. Jensen
attempted to develop an absolute measure for performance evaluation as opposed to relative
measures previously suggested (Jensen, 1967). He derived a term called Jensens alpha, which
basically calculates whether the fund manager has been successful in beating the market using his
forecasting ability or not. According to him, a manager forecasting ability consist of ability to
forecast the price movements of individual securities and/or an ability to forecast the general
behavior of security prices in the future, and then accordingly buying, selling or holding
securities. However, according to Roll (1978), Jensens model is very sensitive to the benchmark
chosen because the model is more of beta based i.e. the market risk and so the choice of
benchmark can affect the result.
Asebedo & Grable (2004) identified as an important factor influencing mutual funds
performance. He argues that fund managers control all sorts of decision making related to
investment by the fund, therefore their style influences the fund to a great deal. Fund managers
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also control the diversification and turnover of funds assets which again influence fund
performance (Malhotra & Mcleod, 1997 and Fredman, 1999).
Alongside Fund Managers Style, his experience also plays an important role in the overall
performance. Experienced fund mangers would definitely have more knowledge and know how
of the market and how to react in certain situations as compared to young managers. Markese
(2000) indicated that mutual funds with new and inexperienced managers should be avoided as
there is no surety of their performance. Added to that Golec (1996) concluded from his study that
the funds exhibiting good performance are usually the ones managed by experienced managers.
3.
Methodology
3.1
Data
After 2004, mutual fund industry in Pakistan has shown growth in terms of participation of
private sector and divestment of public sector funds. Presently there are more than 50 mutual
funds which are operating in different regions of the country. The sample size of this study is 10
mutual funds companies which are included in both open end and closed end mutual funds.
Variables used for the performance evaluation of mutual funds are net income after taxes of
funds, net asset value, number of certificates/shares outstanding, earning per certificate and net
asset value per certificate/share, monthly returns of KSE 100 index. Six months Treasury bill
rates. Return of fund was calculated by dividing net income after taxes of a fund by opening net
assets of the fund for that year.
3.2
Research Models
3.2.1 The Sharpe Model

In 1960 William F. Sharpe started to work on portfolio theory as thesis project. He introduced the
concept of risk free asset. Combing the risk free asset with the Markowitz efficient portfolio he
introduced the capital market line as the efficient portfolio line. The model given by Sharpe, we
can proceed further to use it for the determination of expected rate of return for a risky asset,
which led to the development of CAPM capital asset pricing model. Through this model an
investor can know what should be the required rate of return for a risky asset. The required rate of
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return has a great significance for the valuation of securities, by discounting its cash flows with
the required rate of return.
In order to determine which portfolio offering the most favorable risk/return trade-off, we
compute the ratio of the historical returns in excess of the risk-free rate to the standard deviation
of the portfolio returns.
Sharpe introduced the following reward to variability ratio (known as Sharpe ratio):
Sharpe Ratio =
(Rp-Rf)/ S p
Where Rp = the average Fund return.

Rf = the average risk free return.
S p = the standard deviation of fund returns.
This model is used to measure the performance of a managed portfolio in respect of return per
unit of risk. This ratio also measures the portfolio managers ability on the basis of rate of return
performance and diversification by taking into account total risk of the portfolio.
------------------------------------------Insert Table 1 Here-----------------------------------------------Funds are ranked according to the Sharpe rule, which states that in the assessing the merits of two
funds we have to choose the fund with the higher Sharpe ratio. An investor with a different risk
preference might prefer a different ranking.
------------------------------------------Insert Table 2 Here-------------------------------------------------The Sharpe ratio for mutual funds is typically between 0.5 and 3. A rule of thumb is that if the
annualized Sharpe Ratio is over 1.0 the fund had a pretty good year. Outstanding funds have a
Sharpe Ratio over 2.0(Investopedia.com 2007). From this point of view, most Pakistans mutual
funds might be characterized as not pretty good. But some funds performance is pretty good
because their Sharpe ratio is 1. Results show, (Table 1.2) that some one of the funds have
negative Sharpe ratio which indicate the managers inability in diversification.
3.2.2 The Treynor Model
Treynor introduced two types of risks. One risk is called Systematic risk which is associated with
market and cannot be diversified away. However, this type of risk can by calculated through
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beta. Treynor says that portfolio expected return depend on its beta. The other type of risk
which he separated from systematic risk is unsystematic risk. Unsystematic risk is specific to a
company. The uncertainty attached with the specific company can be diversified away.
Treynor model is used to measure the performance of a managed portfolio in respect of return per
unit of risk (systemic risk). In this way the mutual fund provides the highest return per unit of risk
(systemic risk) will be preferred as compared to the fund provides low return per unit of risk.
Treynor ratio uses Beta as a risk measure hence considers the Systematic risk. This ratio also
measures the portfolio managers ability on the basis of rate of return performance and
diversification by taking into account systemic risk of the portfolio. This ratio measures the
historical performance of managed portfolio in terms of return per unit of risk (systemic risk).
Treynor Ratio = (Rp Rf) /
Rp = the observed average fund return;
Rf = the average risk free return;
= coefficient as a measure of systematic risk
Treynor Ratio indicate that the portfolio offering the highest reward/risk (systemic risk) ratio will
be the only risky portfolio in which investors will choose to invest. The assumption is that the
portfolio manager has diversified away the diversifiable risk (unsystematic risk/company specific
risk) and the matter of concern for the investor should be the systematic risk (nondiversifiable/market risk) only, instead of total risk. I computed the ratio of the historical returns,
in excess of the risk-free rate (T-Bill rate) to the systemic risk of the portfolio returns of the
Pakistani funds for the period from 2004 to 2008. Results show that all funds have beta less than
1, in some cases significantly less than 1, regarding systemic risk we can conclude that all mutual
funds are defensive in their movement of returns as compared to the market returns (KSE 100
index). 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 same.
---------------------------------------Insert Table 3 Here-----------------------------------------------------
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4.
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Conclusion
This paper provides an overview of the Pakistani mutual fund industry and investigates the
mutual funds risk adjusted performance using mutual fund performance evaluation models. For
this purpose the data of equity and balanced funds is used for the performance evaluation of
funds. Mutual fund industry in Pakistan is still in growing phase. Result shows that on overall
basis, funds industry outperform the market proxy by 0.86 percent. They are investing in the
market very defensively as evident from their beta. Where as results also show some of the funds
under perform, these funds are facing the diversification problem. Worldwide there had been a
tremendous growth in this industry; this growth in mutual funds worldwide is because of the
overall growth in both the size and maturity of many foreign capital markets, we are far behind.
The need of an hour is to mobilise saving of the individual investors through the offering of
variety of funds (with different investment objectives).
The funds should also disclose the level of risk associated with return in their annual reports for
the information of investors and prospective investors. This will enable the investors to compare
the level of return with the level of risk. The success of this sector depends on the performance of
funds industry and the role of regulatory bodies. Excellent performance and stringent regulations
will increase the popularity of mutual funds in Pakistan.
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References
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Securities. Journal of Portfolio Management 26:2, 921.
Otten, Roger, and Dennis Bams (2004) How to Measure Mutual Funds Performance: Economic
Versus Statistical Relevance. Journal of Accounting and Finance 44, 203222.
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Management 8:1, 75101.
Sharpe, William F. (1966) Mutual Fund Performance. Journal of Business 39 (January),
Supplement on Security Prices, 11938.
Warmer, R. (2000) Mutual Funds Performance: An Empirical Decomposition into Stock-picking
Talent, Styles, Transaction Cost and Expenses. Journal of Finance 4: August.
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Financial Companies in Corporate Governance. CMER Working Paper No. 06-46,
Lahore: Lahore University of Management Sciences. [Forthcoming]
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Saeed, M. Akbar, and Nadeem A. Syed (2005). Corporate Governance of Mutual funds in
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Annexu re
Table1: Annual Growth Rate for Different Mutual Funds in Pakistan (2004-2008)
2004
2005
2006
2007
2008
0.071
0.093
0.108
0.0974
0.093
Faysal Balance Growth Fund
0.0157
0.132
0.025
0.1732
0.1221
Atlas Asset Management Ltd
0.037
0.089
0.103
0.0928
0.1044
Al Meezan Mutual Fund
0.216
0.257
0.216
0.2464
-0.006
Golden Arrow Selected Fund
0.385
0.288
0.273
0.3182
0.0284
Crosby Dragon Fund
0.021
0.101
0.129
0.387
0.3277
PICIC Asset Management company Ltd
0.144
0.108
0.314
0.1732
0.0496
UBL Fund Managers
0.044
0.041
0.086
0.0931
0.106
Safe Way Mutual Fund Ltd
0.279
0.02
0.002
0.195
0.025
First Capital Mutual Fund Ltd
1.783
0.168
0.274
0.3008
0.1264
Dawood Capital Management Ltd
Table 2: Pakistans Mutual Funds by the Value of Sharpe Ratio

Crosby Dragon Fund
UBL Fund Managers
Fund Size
Mil.PKR
Avg Annualized
Return
Excess
Return
Standard
Deviation
Sharp Ratio
2351
869
2441
1440
1752
1212
5702
5224
798
231
0.0925
0.2589
0.0854
0.1863
0.0874
0.1934
0.1383
0.0743
0.1052
0.48
0.013527
0.179945
0.006461
0.107309
0.00837
0.114403
0.059295
-0.00465
0.026257
0.401047
0.0134
0.1358
0.0276
0.1090
0.0792
0.1562
0.1308
0.0294
0.1246
0.7477
1.005
1.324
0.233
0.983
0.105
0.732
0.452
-0.158
0.210
0.536
Table 3: Pakistans Mutual Funds by the Value of Treynor Ratio

Sharp Ratio
Beta
Treynor Ratio
1.005
0.75
-0.0128
1.324
0.83
0.0078
0.233
0.63
-0.0339
0.983
0.93
0.1013
0.105
0.71
0.1476
Crosby Dragon Fund
0.732
0.54
0.047
0.452
0.64
0.0148
UBL Fund Managers
-0.158
0.38
-0.1336
0.21
0.69
-0.0096
0.536
0.71
0.368
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