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.

<B>BRR: What is the total size of the mutual fund industry of Pakistan? What has been the growth trend of the industry over the last decade?</B>

<B>DAW:</B> The current size of the mutual fund industry is around Rs600 billion. A major chunk of growth in the industry over the last decade has come from increase in the value of the stock market, money market, and other assets held by mutual funds. The unit sales growth, which reflects growth of new investors in the mutual fund industry, has been under 4 percent per annum in the last decade.

<B>BRR: How do you compare the mutual fund industry in India versus Pakistan?</B>

<B>DAW:</B> Ten years ago, the mutual fund industry in Pakistan was 2 percent of our GDP whereas today it still has the same proportion. During the same ten years in India, the mutual fund industry size has risen from 5 percent of its GDP to 16 percent of GDP. In India, there are presently about 50 million investors in mutual funds. Our population is one-seventh that of India, so we should have around 7 million mutual funds investors if our industry had grown like India. However, currently there are only 0.25 million mutual fund investors in Pakistan.

The low size of the mutual fund industry is the key reason due to which savings and investment rate in Pakistan is among the lowest in the world. When sales load restrictions were imposed on the Indian mutual fund industry, the average size of an asset management company (AMC) in India was Rs175 billion. In Pakistan sales load restrictions were placed on the industry when the average size of an AMC was around Rs20 billion. So, Indian mutual fund industry had the economies of scale to survive such load restrictions, and still grow retail business, which is not the case in Pakistan.

Moreover, there are no restrictions on charging of selling and marketing expenses to funds in India, which has tremendously helped in the growth of their mutual fund industry. The size of the Indian mutual fund industry is over $242 billion at present. Our GDP is one-seventh that of India. On this basis, our mutual fund industry should have been $34 billion, whereas it is presently only $6 billion. Had our industry grown at the same pace as India, we would have enough domestic savings to grow our investments, infrastructure and economy, and our successive governments would not have to rely on borrowing heavily via National Savings Schemes, Euro bonds, IMF, etc.

<B>BRR: How do you compare the mutual fund industry with the insurance industry in Pakistan?</B>

<B>DAW:</B> For the life insurance industry, the regulator allows a sales load of 70 percent in the first year, 30 percent in the second year, 10 percent in the third year, and 5 percent per year thereafter. Moreover, there is no restriction on charging of sales load to walk-in and on-line clients. So, the insurance industry has grown at a much faster pace than the mutual fund industry. The number of insurance holders in Pakistan is about 28 million versus 0.25 million mutual fund investors at present. Due to charging of higher sales loads, the insurance industry has been able to hire a sales staff of over 100,000 versus 1,200 in the mutual fund industry.

<B>BRR: How much is NAFA's size? How have NAFA funds performed over the past few years?</B>

<B>DAW:</B> NAFA is rated AM2++ by PACRA, which is the highest rating offered to any asset management company in the country. The rating is primarily based on quality of management, performance of funds, and risk mitigation systems of an asset management company. NAFA is presently managing Rs88 billion of investors' money, which makes it the third largest asset management company in the country. We have a sales staff of about 400 persons marketing our funds throughout the country, which is the largest sales force of any asset management company in the country.

Our NAFA Stock Fund is our flagship fund, which is the best performing stock fund of CY 2016. It provided a 51.5 percent return to its investors in 2016 versus a 46 percent rise in the stock market (KSE 100 Index), and an average return of 39 percent on other stock funds in the country. NAFA Islamic Stock fund, NAFA Islamic Asset Allocation Fund, and Islamic Pension Fund (equity) are among the best performing funds in the country. Our Islamic mutual funds are our fastest growing segment.

<B>BRR: What are your views on the stock market and where it's heading?</B>

<B>DAW:</B> The Pakistani stock market has been among the top performing markets in the world over the last few years. Despite a substantial rise in the stock market it is expected to continue to perform well in the coming years due to the following reasons:

1. The forward price-to-earnings ratio of the Pakistani stock market is 11 times. This means if you buy a share of a company for Rs11, on average, you will get Rs1 of earnings from that company against that share. This is very attractive versus other regional and emerging markets. In India, for example, when an investor buys a share of a company for Rs16, on average, they get Rs1 of earnings from that company against the share.

2. The low interest rates offered by banks over the last few years have compelled investors to move their assets towards the stock market. This trend is expected to continue.

3. Pakistan will become a part of the MSCI Emerging Markets Index in May 2017. Presently about $1.5 trillion is invested in emerging stock markets. Pakistan's weight in Emerging Markets Index is a marginal 0.13 percent.

However, this still amounts to about $2 billion. This is the amount that foreign fund managers are expected to invest in Pakistan over the next few years. The stock market is expected to appreciate as a result of these inflows.

4. The corporate earnings of the KSE 100 Index companies are expected to rise by 15 percent per annum in 2017 and 2018. This will also give impetus to the stock market.