'Retail mutual fund industry growth is constrained due to pricing restrictions,' says CEO NAFA

BR Research recently sat down with Dr Amjad Waheed, the CEO of NBP Fullerton Asset Management Ltd (NAFA) to have a candid conversation about the state of the mutual fund industry of Pakistan along with NAFA's exceptional performance. NAFA is presently managing twenty mutual and pension funds, and several portfolios with total assets under management of NAFA presently about Rs88 billion. Dr Amjad Waheed holds a doctorate in Investments & Finance from Southern Illinois University, USA, and is also a Chartered Financial Analyst. Before joining NAFA, Dr Amjad was Head of Equity Mutual Funds & Portfolios at Riyadh Bank, Saudi Arabia, for about 5 years where he was managing US $7.5 billion invested in 22 mutual funds. Below are edited excerpts from the interview.

<B>BR Research: How has the mutual fund industry performed recently in light of the low interest rate environment and the booming stock market?</B>

<B>Dr Amjad Waheed:</B> Broadly speaking there are three client segments that the mutual fund industry is presently serving. The first is the treasury money of companies. This previously used to go to banks but now some of it is being invested in money market/income mutual funds. We can now pay the investors back generally within a day, so these funds are very liquid. The return on these funds is around 5 percent per annum, which is better than or equal to what banks pay. Previously there were certain tax advantages when companies invested in money market/income funds, but these have been gradually minimised to a great degree. Due to lower interest rates over the last three years, banking spreads have declined from about 7.5 to 5 percent. This has made it difficult for banks to offer very high rates of returns to companies, which has made money market funds more attractive for companies.

The second segment that the mutual fund industry is catering to is the retail investors. Banks typically offer no return on current accounts and about 4 percent on savings accounts. Money market/income funds are presently offering a 5 percent return to investors, irrespective of the size of the investment. Therefore, mutual funds are especially attractive to small investors as they generally earn a much lower return from banks. Due to the good performance of the stock market and the fact that many mutual funds have provided a better return than the stock market, the number of investors investing in equity-related mutual funds has also increased over the last few years. Retail investors are gradually learning the benefits of expert investment management, diversification, tax-benefits, and one-window operation that mutual funds offer. This increasing awareness will help the industry grow faster in the future.

The third segment that mutual funds cater to is employees' funds and endowments. Previously companies used to manage their employee funds themselves. But in the previous five years there has been an increasing trend of outsourcing these funds to mutual funds. Typically, employee funds were invested in banks and government securities. However, as the return on these avenues has declined considerably over the last few years, these funds have started investing a portion of their money in equity and balanced funds to improve their returns. Since employee funds and endowments are long-term in nature they can afford to take some equity exposure, as equities have outperformed fixed income investment avenues by a large margin over the long-run.

The most dominant segment globally for mutual funds is the retail segment, which constitutes about 80 percent of the global asset base of mutual funds.

Unfortunately, in Pakistan the retail segment is still only about 20 percent of the industry.

<B>BRR: Could you please elaborate on the reasons for such a low penetration rate in the retail area for mutual funds?</B>

<B>DAW:</B> Let me start with asking you a question. Have you ever seen a mutual fund sales office anywhere? The answer is most probably no, and the primary reason is the amount of restrictions the regulator has historically placed on the pricing of mutual funds. It has simply not been feasible for the mutual fund industry to set up retail outlets because no one invests in a business that is not profitable.

Pakistan is the only country in the world where there is a cap on charging of management fee on the funds by the regulator. It is one of the three countries in the world where expense ratios are capped by the regulator along with restrictions on charging of sales load. Load is the primary source that covers the rental, utility, and running expenses of a sales branch, and salaries and commissions of the sales staff. The restriction on charging of sales load to walk-in and on-line clients is hindering the growth of our sales branches, which are presently only 1 percent of the total bank branches in the country.

There were also restrictions on charging of selling and marketing expenses to the funds. However, we are thankful to SECP for recently allowing charging of selling and marketing expenses to the funds in line with international practices. Such charges have been restricted to 0.4 percent of the fund size, which is reasonable. Although in most countries in the world it is left to the market forces to determine the extent of such charges. This positive step of SECP will help accelerate retail segment growth. The regulator has however restricted charging of such sales and marketing expenses to equity-related funds only. In all the global jurisdictions that we have studied, such charging is allowed on all categories of funds.

The average return on current and savings accounts of banks is presently around 2.2 percent per annum, whereas money market funds are presently offering an average return of 4.9 percent per annum. However, very few retail investors are even aware of the existence of money market funds because we do not have the resources to expand our distribution network to reach the general public. Even if 0.4 percent of selling and marketing expenses are allowed to be charged on money market/income funds, and consequently the return to the investor in these funds decreases from 4.9 percent per annum to 4.5 percent per annum, the investors will still be earning almost double the return of what they are earning on bank deposits. However, the mutual fund industry will have sufficient resources to expand our distribution reach to market and educate the retail investors. I request SECP to allow charging of marketing and sales expenses to fixed income funds as well to promote the industry, and help small investors earn better returns on their investments.