Lect 2

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MUTUAL FUNDS By Dr Sabeeh

WHY MUTUAL FUNDS?


1. It gives a diversification in our portfolio
2. We can start investment with a very low
investment.
3. Various funds available for different risk
return profiles.
4. Full liquidity available for any urgent
needs
5. More cost efficient then direct equity
investments
6. Less research required
7. Benefits of expertise of fund managers
8. Reduce the Tax liabilities
MUTUAL FUNDS
Mutual Fund is an investment vehicle that is made up of a
collection of funds from different investors for the
purpose of investing in securities such as bonds, stock
market, money market instruments and similar assets.
Mutual fund investments are governed by Money
Managers or the Fund Managers, who invest to create
capital gains and income for the investors.
MUTUAL FUNDS
The underlying rationality of mutual funds is that they deliver
diverse investments — in stocks, bonds and cash — without
requiring investors to make separate purchases or trades.
You can think of it as a house that brings together a crowd of
people diversify their investments to generate capital gain.
Each investor gets his own portion which depicts a percentage of
the holdings of the fund.
ORGANIZATION OF MUTUAL
FUND Sponsor or Asset
Management Company: The
sponsor, also known as the
asset management company, is
responsible for creating and
managing the mutual fund.

Mutual Fund organized as MF organized as investment


trust, the board of trustees company, the board of
appointed by AMC directors appointed by AMC
CLOSED-END MUTUAL FUND
Closed-end funds are a type of
investment company that is structured
as a corporation and is publicly traded
on stock exchanges, similar to
individual stocks. Here are some key
characteristics of closed-end mutual
funds organized as companies:
Fixed Number of Shares: Closed-end
funds issue a fixed number of shares
during their initial public offering
(IPO). These shares are then traded
on stock exchanges, just like stocks of
publicly traded companies.
CHARACTERISTICS OF
CLOSED-END MUTUAL
Managed Portfolio: Closed-end funds have a
FUND
professionally managed portfolio of
investments, which can include stocks,
bonds, or other securities, depending on the
fund's objectives. Portfolio managers make
investment decisions in line with the fund's
stated goals.
Diversification: Like open-end mutual
funds, closed-end funds often provide
diversification by investing in a range of
assets. This diversification can help spread
risk for investors.
CHARACTERISTICS OF
CLOSED-END MUTUAL FUND
Dividends and Distributions: Closed-end funds may pay regular dividends or
distributions to their shareholders. These payments can come from the
income generated by the fund's underlying investments, such as dividends
from stocks or interest from bonds.
Leverage: Some closed-end funds use leverage to enhance returns. They may
borrow money to invest alongside the capital from shareholders, potentially
increasing the fund's exposure to its chosen asset class.
Secondary Market Liquidity: Closed-end funds provide investors with the
opportunity to trade fund shares on secondary markets. However, liquidity
can vary, and the trading volume of some closed-end funds may be lower
than that of widely traded stocks.
OPEN-END MUTUAL FUND
A mutual fund organized as a trust is commonly referred
to as an "open-end mutual fund." This is the most
prevalent structure for mutual funds. In this organizational
structure, the mutual fund operates as a trust, and
investors purchase shares directly from the fund, or
through intermediaries like brokers or financial
institutions. Here are some key characteristics of open-
end mutual funds organized as trusts:
Continuous Issuance and Redemption of Shares: Open-
end mutual funds offer shares on an ongoing basis.
Investors can buy shares from the fund at the current net
asset value (NAV) and sell them back to the fund at the
NAV. The price at which shares are bought or sold is
typically determined at the end of each trading day, based
on the NAV.
CHARACTERISTICS OF OPEN-
END MUTUAL
Diversified Portfolio: FUND
These funds hold a diversified portfolio of securities, which can include
stocks, bonds, and other assets. Diversification is a key feature that helps spread risk across
different investments.
Professional Management: Open-end mutual funds are managed by professional portfolio
managers who make investment decisions in line with the fund's stated objectives. The managers
buy and sell securities within the fund's portfolio to achieve its investment goals.
Net Asset Value (NAV): The NAV is the total value of the fund's assets minus its liabilities,
divided by the number of outstanding shares. The NAV is typically calculated at the end of each
trading day and represents the per-share value of the fund.
Redemption at NAV: Investors can redeem their shares at the NAV price, meaning they can sell
their holdings back to the fund at the end-of-day calculated NAV. This feature provides liquidity
and allows investors to easily access their investments.
Dividends and Capital Gains Distributions: Open-end mutual funds may distribute income (e.g.,
interest, dividends) and capital gains to shareholders. These distributions can be made
periodically, such as monthly or annually.
CHARACTERISTICS OF OPEN-
END MUTUAL FUND
No Secondary Market Trading: Unlike closed-end funds, open-end funds do
not trade on secondary markets like stock exchanges. Investors transact
directly with the mutual fund company or an intermediary.
No Limit on the Number of Shares: Open-end funds can create or redeem
shares to accommodate investor demand, so the number of outstanding shares
can vary.
Simplified Ownership: Investors in open-end mutual funds own shares in the
fund itself rather than holding a direct interest in the underlying assets. This
structure simplifies ownership and makes it easy for individual investors to
access professionally managed portfolios.
TYPES OF MUTUAL FUNDS: Summary
There are basically two types of Mutual Funds: Open-Ended Mutual Funds and
Closed-Ended Mutual Funds
Open-ended:
These are mutual funds which continually create new units or redeem issued units
on demand. They are also called Unit Trusts. The Unit holders buy the Units of
the fund or may redeem them on a continuous basis at the prevailing Net Asset
Value (NAV). These units can be purchased and redeemed through Management
Company which announces offer and redemption prices daily.
Close-ended
These funds have a fixed number of shares like a public company and are floated
through an IPO. Once issued, they can be bought and sold at the market rates in
secondary market (Stock Exchange). The market rate is announced daily by the
stock exchange.
TYPES OF FUNDS
Types of Mutual Funds Each mutual fund has specific investment objectives that
mould the fund's assets, investment options and strategy.
At the most basic level, there are three types of mutual funds:
(i) Equity funds,
ii) Fixed-income funds, and
iii) Money Market funds.
All the other kinds of mutual funds are variations of these three basic types.
TYPES OF FUNDS
Growth Fund :
 A mutual fund whose focal aim is to achieve
capital appreciation primarily by investing in
growth stocks.
 In pursuit of large capital gains, these funds
invest in companies with significant earnings or
revenue growth, rather than those with high
pay-outs.
 In general, growth funds are more volatile than
other types of funds.
TYPES OF FUNDS
Asset Allocation Fund :
This type of mutual fund invests in a variety of
securities in multiple asset classes with the
objective of carrying out asset allocation typically
by itself.
The rationale is to provide investors with suitably
diversified holdings and consistent returns.
Generally, asset allocation funds are less volatile.
Asset allocation involves dividing your
investments among different assets, such as
stocks, bonds, and cash.
Among Growth and Asset Allocation Funds,
which are relatively riskier?
TYPES OF FUNDS

Money Market Funds : Treasury


Bills
A mutual fund which invests in low risk
securities, for the most part in
government securities, CODs, Money Market Commercial
commercial paper of companies and other Instruments Papers

highly liquid and low risk securities.


These funds have inherently low risks.
Certificate
of Deposits
Generally, these funds are least volatile.
TYPES OF FUNDS
Tracker Fund:
This type of fund, as its name
suggests, follows the
performance of a particular
index.
Theoretically, these types of
funds are as volatile as the
market.
TYPES OF FUNDS
Fund of Funds:
A type of mutual fund which invests in other
mutual funds, also known as "multi-
management" funds.
These types of funds enable investors to
achieve a broad diversification and an
appropriate asset allocation with investments
in a variety of fund categories that all are
wrapped up into one fund.
Due to diversification, these funds are less
volatile with moderate correlation with
market.
TYPES OF FUNDS
Income Fund:
A type of mutual fund that emphasizes
current income, either on a monthly or
quarterly basis, as divergent from
targeting capital appreciation.
These funds hold a variety of government
and corporate debt obligations, preferred
stock, money market instruments and
dividend paying stocks.
Generally, these funds are least volatile.
TYPES OF FUNDS
Balanced Fund:
Mutual funds that combine investments in shares, short-term and long-
term bonds in pursuit of income gains and capital appreciation while
avoiding excessive risk.
These are also called hybrid funds. The idea behind this concept is to
provide investors with a single mutual fund that combines income and
growth objectives, by investing in both stocks and bonds.
Due to diversification, these funds are less volatile with moderate
correlation with market.
TYPES OF FUNDS
Equity Fund : A mutual fund that invests principally in stocks is called equity fund.
It is also known as a "stock fund".
Generally, these funds are very volatile.
Sector Fund : A mutual fund that invests entirely or predominantly in a specified
(single) sector is a sector specific fund. These funds usually exist in energy, gold,
and other precious metals sectors.
The risk associated with these funds depends on the specified sector.
These types of funds are less diversified.
Islamic Funds : A type of fund which entirely invests in Shariah compliant
instruments. Islamic funds exist in almost all the forms discussed earlier.
TYPES OF FUNDS
Capital-protected mutual funds, also known as capital-guaranteed funds or
principal-protected funds, are a type of investment fund designed to provide
investors with a degree of principal protection, ensuring that they will receive at
least their initial investment back, plus the potential for additional returns. These
funds are often structured to strike a balance between preserving capital and
generating returns. Here's how they work:
 Principal Protection
 Investment Strategy: Low risk assets.
 Returns: Low Return
 Maturity Period: Capital-protected funds typically have a defined maturity period, such as 3, 5,
or 10 years.
FEES AND EXPENSES OF
MUTUAL FUNDS
Running a mutual fund involves costs such as
Transaction costs: Broker Commissions, and Exchange Fees, etc.
Investment advisory fees, and
Marketing and distribution expenses.
It is important to understand that these charges will lower
your return. Mutual funds transfer these costs to investor
FEES AND EXPENSES OF
MUTUAL FUNDS
Front –end load: This includes sales and processing charges payable by an investor
upon purchase of units and is expressed as a percentage of the NAV.

Let's say you want to invest $10,000 in a mutual fund with a front-end load of 5%. When
you invest, the following steps occur:
Initial Investment Amount: You decide to invest $10,000 in the mutual fund.
Front-End Load Percentage: The mutual fund has a front-end load of 5%, which means 5%
of your investment will be deducted as a sales charge.
Load Deduction: When you invest your $10,000, the mutual fund will deduct 5% from
your investment upfront. In this case, 5% of $10,000 is $500.
Actual Investment: After the front-end load is deducted, your actual investment in the
mutual fund is $10,000 - $500 = $9,500.
FEES AND EXPENSES OF
MUTUAL FUNDS
Back-end load:
This is paid by an investor when the units are bought back by the
fund.
Back-end load is generally charged by funds in place of a front
end load, and is also referred to as deferred sales charge.
This typically goes to the AMC or third party distributor who
sells the fund’s units.
FEES AND EXPENSES OF
MUTUAL FUNDS
Contingent load:
This is charged by capital protected mutual funds on early redemption of the
investment before expiry of the fixed maturity period.
However, the mutual funds progressively reduce the load if an investor holds
the investment for a longer period of time.
FEES AND EXPENSES OF
MUTUAL FUNDS
No-load fund (Zero-load):
A no-load fund is a mutual fund in which units are sold
without a commission or sales charge.
Because there is no transaction cost to purchase a no-load
fund, all of the money invested is working for the
investor.
FEES AND EXPENSES OF
MUTUAL FUNDS
Trustee fee
The trustee is the custodian of the fund’s assets and also
ensures that the fund manager’s investment decisions are
in accordance with the fund’s defined investment policy.
The trustee is entitled to a monthly remuneration as per
the structure disclosed in the offering document.
FEES AND EXPENSES OF
MUTUAL FUNDS
Other fees:
All expenses incurred in connection with formation and registration
of open-end mutual funds including but not limited to:
 execution and registration of constitutive documents;
 fees payable to SECP,
 auditor’s fee,
 fees payable to rating agencies,
 brokerage and transaction costs,
 cost of registration of assets in the name of trustee, and
 listing fees payable to the stock exchange.
EXAMPLE

Assume 8000 shares are outstanding.


EXPENSE RATIO
This expresses the mutual fund’s annual fund operating expenses as a
percentage of the fund’s average net assets.
The expense ratio of a stock or equity fund is the total percentage of
fund assets used for administrative, management, advertising and all
other expenses.
An expense ratio of 1% per annum means that each year 1% of the
fund's total assets will be used to cover expenses.
The expense ratio does not include sales loads or brokerage
commissions. Expense ratios are important to consider when choosing a
fund, as they can significantly affect returns.
HOW MUTUAL FUNDS CAN
INCREASE YOUR WEALTH?
A mutual fund can increase your wealth through:
Dividend Payments: A mutual funds earns income in
the form of dividends and interest on the securities in
its portfolio. Dividend is paid in the form of cash on
monthly/quarterly/annual basis depending on the
category of the fund. The AMC will issue new units for
the price of the re-invested dividend amount.
Capital Gains Distributions: The price of the securities
in a mutual fund’s portfolio may increase. When a fund
sells a security that has increased in price, the fund has
a capital gain. At the end of the financial year or during
the year, funds may distribute these capital gains
(minus any capital losses) to you.
HOW MUTUAL FUNDS CAN
INCREASE YOUR WEALTH?
Increased NAV: When the price of a fund increases due to appreciation in the
overall portfolio of the fund, it results in capital gains for investors who can
redeem their units at a higher price.
Tax benefit: Individual investors in mutual funds, other than an entity, are
entitled to a tax credit on the purchase of new units under Section 62 of the
Income Tax Ordinance 2001.

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