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A new era of fund management in Pakistan.

A New Era of Fund Management in Pakistan

First Interfund Modaraba is the first Modaraba in Pakistan functioning as a closed end unit trust and providing fund management services in the equities market. So far these activities were confined to the government controlled ICP and NIT only. Participation of private sector in this field opens up tremendous venues of systematic growth in the stock market, which was a burning need of the time. This not only offers the enhanced capital base to the market but also introduces the approach of rational decision making based on thorough analysis of the economy, the industry, and the individual companies. It has also obliged the individual investors to follow the approach of considering the various financial indicators while making investment decisions. Similarly, institutional investors have also realized the need for revising their portfolio and redeveloping it on more scientific lines.

Concepts of Portfolio


The concept of portfolio investment can be traced to the old saying "Never place all your eggs in one basket". However, the roots of modern day portfolio management can be more directly related to the Capital Asset Pricing Model (CAPM). CAPM states that a proper mix of securities enables the investor to eliminate the risk related to the financial managerial performance of individual securities, and the only risk the fund manager should be concerned about is the systematic risk which arises from the general factors, like unforeseen changes in overall economic, political or social conditions. The theory of efficient portfolio relies on either of the following approaches: 1. To earn a maximum possible level of

return at a specified level of risk, or 2. To reduce the risk to a minimum possible

level to earn a required level of


Required rate of return

The required level of return on common stock portfolios should obviously be higher than the risk free rate of return in the economy offered by the government securities. Pertaining to our market this risk free rate of return is about 12.5 per cent which is offered on KDC investments. In order to ascertain the risk premium to be paid on the common stock portfolio various approaches can be adopted, depending upon individual preferences.

A portfolio of securities rising in a higher proportion than the market as a whole is definitely an aggressive investment while a portfolio with security prices moving in lower proportion than the market as a whole is a defensive investment. However, a moderate approach is to be followed by the institutional investor, as it is dealing with public funds and has the responsibility of earning the maximum possible level of return at an acceptable level of risk which the individual himself cannot earn from any other venue of investment. Development of Security Selection System.

The is no single rule of thumb to develop the successful security selection system. The choice of technique varies with the objective of the investor. While the large investor with controlling interest in the organization gives preferences to its asset value, the small investor relies more on earning potential and dividend payments of the company. Similarly, the fundamental analyst gives all the reasons of validity of financial ratios, while the technical analyst feels more confident knowing the price trend of the share over a period of time. Besides, many non-financial factors also play a vital role to turn the actual market conditions favourably or adversely, within a fraction of time. Overnight change of government, rumour of foreign investors, or change in monetary and fiscal policies is enough to change the investment psychology suddenly and can turn the market upside down.

A system based more on sound principles is less likely to be affected by any of the unforeseen events in the economy. Therefore a logical combination of technical and fundamental analysis is required while making rational decisions. In other words, use of financial ratios along with the price trend is crucial to invest profitably in the highly volatile stock market.

There are many financial ratios given in the books of accounting and finance, to gauge the performance of a company, but their applicability in the real market must be tested before using them blindly. For example, a purchase of decision based on high profit ratios is of no good if the market is placing more importance to the dividend rather than earnings. The price of good dividend paying company may rise more in future than the companies with better earnings but less or no dividends.

Quantification of Risk

As stated earlier, according to portfolio management theories, the only risk the fund manager should be dealing with is systematic risk. Market indices can be used as a very appropriate tool to quantify that risk, in terms of beta (B). B measures the price variability of a particular share against the general price variability of the market as a whole during the given period of time. A simplified approach to develop an optimal portfolio is to select the securities with B = 1, as the B of greater than one offers a high leverage factor and a B of less than market indicates a poorly performing share.

Practicability of Theories

Management of First Interfund Modaraba has tested the applicability of all these theories in the local market prior to developing a successful security evaluation and investment system, which has been in operation for the last one year. The system is flexible enough to make timely adjustments to the changing market conditions and to develop positive investment strategies and earn high returns.

Realizing the need of an accurately calculated index of the general market, FIM works out its own daily index with 1988 as the base period. This index is weighted on PUC to adjust for listings of new companies, and issuance of Right and/or Bonus shares by the existing companies. New Approaches to Develop the Stock Market In order to give more depth to the market there is a dire need to introduce new instruments in the stock market. One such instrument is Index Options trading, which will provide stability to the market, as well The stability arising from Index option trading is again based on the portfolio concept - that movement of securities in opposite direction in an index cancels out its unsystematic risk totally, hence making it a secure investment. Besides, index option trading opens the doors of the stock market to common investors also who do not have much knowledge about the financial performance of individual securities.

Finally, with the listing of new companies and enhanced involvement of other financial institutions in the field, it is expected that many other new ideas and approaches will be introduced in the market and the secondary capital market in Pakistan will continue to grow at a past pace at least in the foreseeable future.
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Publication:Economic Review
Date:Aug 1, 1991
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