Growth of Income Funds in Pakistan and analysis. For detailed report or discussion contact jawadiqbalkhan86@yahoo.com

1. Performance Evaluation of Income
Funds in Pakistan
Muhammad Jawad Iqbal Khan
Dated 25th January 2008
NUST Business School, Rawalpindi

2. Introduction
Mutual funds are one of the most studied areas in developed countries due to their
efficient role in reducing the risk and increasing the return through professional
management of the funds. These funds increase the incomes of small investors as well as
reduce the unsystematic risks in the financial decisions.
Pakistan was the pioneer in the field of Mutual Funds in the South Asia Region, when it
launched National Investment Trust (NIT), an open-ended mutual fund in 1962, followed
by the establishment in 1966 of Investment Corporation of Pakistan (ICP), which
launched a series of close-ended mutual funds. Both NIT and ICP were established in the
public sector. However, it subsequently failed to maintain the tempo of the initiative
taken in the field until early nineties mainly due to multiple reasons 1 including frequent
changes in economic policies, high rates of alternative investment such as National
Saving Schemes (NSS), capital outflow, limited investment options, profusion of risk free
investment options in Government securities, lack of awareness among the general public
about collective investment schemes, lack of aggressive marketing and distribution
network .
With the year 2002, a boom in the economy, privatization initiatives and consistent
growth of GDP resulted in higher per capita income. The private sector played a major
role in attracting investments in mutual funds along with professional management and
attractive marketing techniques mutual fund industry grew by an average of 57% since
2003. The total size of the Industry was 2922 Billion Rupees as on June 30th, 2007 (Figure
1
Mutual Fund Industry in Pakistan, By Mr. Mohammad Yasin, Senior Manager, Mutual Funds Association
of Pakistan (MUFAP), retrieved on 15th January 2008 from www.mufap.com.pk
2
Approximate value based on data collected from Business Recorder and Mutual Funds Reports.
2

3. 1, Appendix). A total of 273 open end mutual funds were launched during the year
comprising 11open end income funds, 6 pure equity funds, 4 Islamic funds, 3 Hybrid
funds, 2 Balanced funds and 1 Assets Allocation fund. In 2002 the total number of funds
was less than 10 which increased to 32 in 2006 and subsequently to 59 in 2007(Figure 2,
Appendix).
The focus of the research on mutual funds in Pakistan is limited and mostly confined to
the performance evaluation of Equity Funds, mainly due to their dominance in the
industry as well as importance of the stock market performance in the country. The
income funds in this industry constituted only 8% in 2003. With an average growth rate
of 142%, its share increased to 37% showing an impressive growth of 295% in
2007(Figure 3, Appendix). Since 2002, the cumulative size of income funds grew 4 at a 5
year CAGR of 124% where as the cumulative size of equity funds grew at 5 year CAGR
of 43%.
This growth and entrance of prominent players in Mutual Funds including MCB
Commercial Bank Limited and Habib Bank Limited has stressed the need of performance
evaluation of these funds. The newly emerged income funds have a life span of less than
two years which generally disqualify them from evaluation process due to short span of
time. But they are included in this paper in order to get an indication of their possible
future position in the industry based on the startup performance. Also Institutions like
banks especially largest banks of Pakistan have more information, access and expertise
available for acquiring funds and investing them. So their analysis is vital in the future of
the mutual fund industry.
3
Figures taken from Daily Market Review on January 22nd, 2008 by IGI Securities Limited
4
ibid
3

4. Literature Review
Mutual Funds, which are actively managed, generally under perform the market on
average. This trend is more visible in the money market funds where difference between
market return, risk free rate and fund performance is in the range of 1%. The low risk
nature of these investments as compared to equity funds result in lower return which in
turn leaves little or no room for management expenses. The mutual fund industry of
Pakistan is in growing stage (Shah and Hijazi, 2005).Equity Funds outperformed the
market and positive return after deducting costs. The funds also have the potential to add
value due to present lack of diversification indicated by the difference in Sharpe and
Treynor Ratios. The proportion of fund which are able to beat the market in a given time
period is low (Naim Sipra, 2006) and no fund was able to beat the market consistently
which indicate the semi strong form of market efficiency. Index funds are able to beat the
market by 100-200 basis points than the actively managed funds. The major reasons for
active funds underperformance are management fees and trading costs (Malkiel and
Radisich, 2004). The funds under perform the market by the amount of expenses charged
by them (Otten and Bams, 2004).
Research Methodology
Hypothesis
Following are the hypothesis which are tested for their validity
1. Income Funds in Pakistan under perform the market when management fees
(Industry standard of 1.5%) are included in return.
2. Above market past performance do not guarantee future performance of the funds.
4

5. 3. Experience and Knowledge of Large Banks will help them to out perform market
especially money markets.
4. Return of the fund cannot indicate the performance of the fund unless risk factors
are included
The Sample
The income funds in Pakistan do not have lifespan more than 10 years and majority of the
funds have lifespan of less than 5 years. The sample for the research consists of 8 Income
funds of 7 Institutions. The funds are
1. MCB Dynamic Cash Fund
2. HBL Income Fund
3. UBL Money Market Fund
4. UBL Income And Growth Fund
5. KASB Liquid Fund
6. FAYSAL Saving Fund
7. ASKARI Income Fund
8. NAFA Cash Fund
Sources of Data
The data required for the research was collected from multiple sources. Risk free rate
(Rf) was taken as 6 month T-Bill and Return on market (Rm) was calculated on the return
of 1 Month Kibor Rates. Both of these rates were taken from the website of State Bank of
Pakistan. The Net Asset Values of the funds were taken from the Business Recorder
5

6. website, Mutual Funds Association of Pakistan website and respective websites of the
funds. The data was collected from July 2004 till December 2007.
Variables
The variables for the evaluation of the performance of the fund were Net Asset Value,
Monthly Return, Beta of the funds return with the Market, Return on Market and Return
of Risk Free Assets, Risk Adjusted Performance.
Methodology
The methods used for the evaluation of the performance are 1) Sharpe Measure 2)
Jensen’s Alpha 3) Treynor’s Measure. The returns of the funds, market and risk free
assets were calculated on monthly basis and converted into effective annual returns. The
Return of the funds does not include the commissions and management fees. This was
done intentionally to evaluate the performance of the newly emerged funds based on their
diversification potential. It was assumed that all funds have to distribute 90% of their
income as dividends at 30th of June in order to avoid taxation. This was also indicated by
the NAV changes at the start of new fiscal year by all the funds. The fiscal year was
considered as one year of performance by a fund.
Sharpe Measure
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. The portfolio offering the highest reward/risk ratio then
is the only risky portfolio in which investors will choose to invest. Using average returns
of the portfolio uses Sharpe ratio to measure ex-post portfolio performance.
6

7. Sharpe Ratio = (Rp-Rf)/ðp
Rp = the observed average fund return;
Rf = the average risk free return;
δ 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 manager’s ability on the
basis of rate of return performance and diversification by taking into account total risk of
the portfolio.
Treynor Measure
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 manager’s 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)/β
Rp = the observed average fund return;
Rf = the average risk free return;
β = 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
7

8. 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 (non-diversifiable/market risk) only, instead of total risk.
Jensen Differential Measure
Jensen in 1969 introduced alpha (α) in the capital asset pricing model to measure the
abnormal return of a portfolio—that is difference between the actual average return
earned by a portfolio and the return that should have been earned by the portfolio given
the market conditions and the risk of the portfolio.
Jensen measure is calculated as follows:
Rp – Rf = α p + β p [Rm – Rf]
Rp = the observed returns of the portfolio
Rf = the risk free returns
Rm = the return on the market index
α and β = are the parameters of the model.
Analysis and Results
Table 1 summarizes the Returns of the funds (Rp) and Returns of the Market (Rm) for
three years. This table indicates that Askari Income Fund performed 2% above the market
on average where as in year 2007 Faysal Saving Fund had the highest return. UBL
Money Fund, one of the oldest funds, underperformed the market by 1% along with HBL
Income Fund, latest fund in the market, which underperformed by 3%. This indicates that
the experience of the funds in Money markets does not guarantee their out performing the
markets. Oldest (UBL Income Fund) and Latest (HBL Income Fund), both under
8

9. performed but the experience of UBL Money Fund gave it advantage of 2%. 6 out of 8
funds could not maintain their performances consecutively for three years. This proves
the hypothesis that the historical performance of a fund does not guarantee its future
performance. These results do not include the 1.5% management fee which is the norm of
the industry. If we deduct this 1.5% from the return, then sample underperformed the
market on average by 0.50%. This highlights the importance of Index Funds in the
Money Markets Mutual Funds of Pakistan as management fees are reduced to minimal
level by mimicking the market.
The table 2 indicates that our sample average Sharpe ratio is 0.88. It indicates that
industry has generated risk premium return of 0.88% per unit of total risk taken by the
funds. The highest average risk premium return earned is by the UBL Money Market
Fund (1.77%) but it has generated negative risk premium return (-0.345%) in 2007. The
highest risk premium return in 2007 is by Askari Income Fund followed by Faysal
Savings Fund (0.82). This ratio determines the fund manager’s performance on the basis
of return as well as diversification. Investors should choose funds which have a consistent
history of generating higher risk return premium based on multi year comparison based
on their intended duration of investment. Long term investors should focus on average
Sharpe Ratio of firm over the years where as short term investors should focus on the
yearly Sharpe ratio. Half of the funds beat the market on the basis of their total risk in the
three year time period. The new comer in industry HBL Income Fund ranked lowest as it
lost 0.221% per unit of risk taken by the fund.
The Industry average for 2006 and 2007 in Table 3 shows a positive Jensen’s alpha of
0.005. This indicates that fund managers are able to pick up securities and time the
9

10. market in such a way that they are able to generate positive income. The industry was
able to beat market return by 0.005 percent per anum. The overall three years Jensen
Alpha is negative (-0.002) largely due to NAFA Cash Fund (-0.052) and Askari Income
Fund (-0.015). The infant funds like MCB Dynamic Cash Fund and HBL income fund
were able to beat the market by 0.005% and 0.002% points respectively. Three of the top
four funds are subsidiaries of Larger Banks of Pakistan indicating that there experience of
bond market is helping them in generating higher return despite less time of operations in
income funds.
Table 4 indicates the Treynor’s measure of Income Funds of our sample. The industry
average is 0.063 and only three funds could beat the market on both diversification and
reduction in unique risk of the fund. Ideally in a well diversified portfolio Sharpe
Measure and Treynor’s Measure should be same. In the sample no fund had the same
value of both measures indicating lack of complete diversification on part of the portfolio
managers. They are not reducing the risk for the investors. The most diversified fund in
the sample is KASB Liquid Fund followed by UBL funds. MCB Dynamic Cash Fund
and Faysal Savings funds had a negative beta which resulted in a lower Treynor’s value.
In reality these funds have performed exemplary as they have invested in securities which
have negative relation with market.
Table 5 lists the summary ranking of the entire sample Income funds on the basis of
Return on Portfolio (Re), Sharpe measure, Jensen’s Alpha and Treynor’s measure. The
fund with highest return significantly lags behind when its return is adjusted for risk. This
indicates that the investors should not only look for the return but also for the risk
involved in it. Risk and Return analysis will result in a decision of investing a fund which
10

11. will have strong tendency of generating highest possible return with lowest possible risk.
This characteristic is indicated by the UBL Income Fund which equals the market return
(9%) but its risk is lowest in all the funds. Among the latest entrants in the market, MCB
Dynamic Cash Fund is the star with lower risk and higher return (10%) which is greater
than the market itself. The future of MCB Cash Fund is bright based on its performance
in the first two years.
Conclusion
The returns of the funds are not the true measure of their performance unless risk factors
are accounted for in the returns. The investors should look for funds which have highest
return with lowest risks to maximize their gain. The returns of the funds over three years
depicted the fact that their performance in one year do not indicate that they will perform
the same in next period. It is evident that Income Funds in Pakistan cannot guarantee
future performance based on past results. We compared the return of fund with return on
market and it proved the hypothesis that Income Funds under perform the market by at
least 50 basis points. This highlight the need of Index funds in the money market of
Pakistan because the difference is already very low and by eliminating management fees
of 1.5% through Index Funds, we will be able to out perform market by 100 basis points.
Experience and knowledge of banks especially Tier 1 banks was not helpful in beating
the market but it helped them to reduce their loss than other funds who did not have such
experience and knowledge.
Recommendations
It is recommended that the institutions that are planning to launch new income funds or
already in the market should launch index funds and risk adjusted returns should be
11

12. emphasized. Investors should invest in funds which match their risk, return and duration
preferences.
Limitations
The time period of this research is three years which may not truly represent the
performance of funds before this period and affect the results. Newly started funds
performance may be over or under estimated due to short span of time.
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13. APPENDIX
Figure 1-Total Assets of Income Funds Vs Mutual Funds Industry
Total Assets of Income Funds Vs Mutual
Funds Industry
300000
250000
200000
150000 Total Industry Size
Income Funds
100000
50000
0
2003 2004 2005 2006 2007
Figure 2-Number of Mutual Funds over the years
Number of Mutual Funds over the
years
80
60
40 Fund Launched
during the year
20
Total number of
0 open end funds
2002 2003 2004 2005 2006 2007
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14. Figure 3-Growth of Income Funds Vs Mutual Funds Industry
Growth of Income Funds Vs Mutual
Funds Industry
300.00%
200.00% Industry Growth
100.00% Income Funds
Growth
0.00%
2003 2004 2005 2006 2007
Table 1-Funds Return Vs Market Return
RP RM RP RM RP RM RP RM
S.NO FUND NAME/YEAR 2005 2005 2006 2006 2007 2007 AVG AVG
1 ASKARI INCOME FUND 0.16 0.09 0.09 0.09 0.10 0.09 0.12 0.09
2 FAYSAL SAVING FUND - 0.09 0.11 0.09 0.11 0.09 0.11 0.09
3 KASB LIQUID FUND 0.10 0.09 0.10 0.09 0.10 0.09 0.10 0.09
4 NAFA CASH FUND 0.10 0.09 0.11 0.09 0.10 0.09 0.10 0.09
5 MCB DYNAMIC CASH FUND - 0.09 0.11 0.10 0.10 0.09 0.10 0.09
6 UBL MONEY MARKET FUND 0.10 0.09 0.10 0.09 0.08 0.09 0.09 0.09
7 UBL INCOME AND GROWTH FUND 0.10 0.09 0.11 0.09 0.07 0.09 0.09 0.09
8 HBL INCOME FUND - 0.09 0.09 0.09 0.06 0.09 0.07 0.09
SAMPLE AVERAGE 0.11 0.09 0.10 0.09 0.09 0.09 0.10 0.09
Table 2-Sharpe Ratio of Income Funds
SHARPE RATIO
FUND NAME/YEAR 2005 2006 2007 AVG Ranking
UBL MONEY MARKET FUND 3.906 1.750 -0.345 1.770 1
NAFA CASH FUND 1.302 2.033 0.610 1.315 2
MCB DYNAMIC CASH FUND 1.810 0.687 1.248 3
FAYSAL SAVING FUND 1.229 0.824 1.027 4
KASB LIQUID FUND 1.048 0.905 0.497 0.817 5
ASKARI INCOME FUND 0.794 0.023 1.488 0.768 6
UBL INCOME AND GROWTH FUND 0.498 0.975 -0.591 0.294 7
HBL INCOME FUND 0.046 -0.489 -0.221 8
SAMPLE AVERAGE 1.510 1.096 0.335 0.877
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15. Table 3-Jensen's Alpha of Income Funds
JENSENS ALPHA
FUND NAME/YEAR 2005 2006 2007 AVG Ranking
UBL MONEY MARKET FUND 0.023 0.039 0.031 1
MCB DYNAMIC CASH FUND 0.019 0.019 0.010 0.016 2
FAYSAL SAVING FUND 0.037 -0.023 0.007 3
HBL INCOME FUND -0.005 0.007 0.001 4
KASB LIQUID FUND 0.009 -0.002 -0.009 -0.001 5
UBL INCOME AND GROWTH FUND -0.036 0.017 0.002 -0.006 6
ASKARI INCOME FUND -0.066 0.023 -0.003 -0.015 7
NAFA CASH FUND -0.102 -0.071 0.017 -0.052 8
SAMPLE AVERAGE -0.035 0.005 0.005 -0.002
Table 4-Treynor's Measure of Income Funds
TREYNOR'S MEASURE
FUND NAME/YEAR 2005 2006 2007 AVG Ranking
KASB LIQUID FUND -0.544 -0.052 1.897 0.434 1
UBL INCOME AND GROWTH FUND 0.002 0.323 0.005 0.110 2
UBL MONEY MARKET FUND 0.013 0.007 0.009 0.010 3
HBL INCOME FUND 0.000 -0.002 -0.001 4
ASKARI INCOME FUND 0.003 0.000 -0.009 -0.002 5
MCB DYNAMIC CASH FUND 0.005 -0.011 -0.003 6
NAFA CASH FUND 0.002 -0.027 0.003 -0.007 7
FAYSAL SAVING FUND -0.063 -0.003 -0.033 8
SAMPLE AVERAGE -0.105 0.024 0.236 0.063
Table 5-Summarized Rankings of Income Funds Performance
FUND NAME RE SHARPE JENSEN TREYNOR
ASKARI INCOME FUND 1 6 7 5
FAYSAL SAVING FUND 2 4 3 8
KASB LIQUID FUND 3 5 5 1
NAFA CASH FUND 4 2 8 7
MCB DYNAMIC CASH FUND 5 3 2 6
UBL MONEY MARKET FUND 6 1 1 3
UBL INCOME AND GROWTH FUND 7 7 6 2
HBL INCOME FUND 8 8 4 4
15

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