Frequently Asked Questions
What are mutual funds?
A mutual fund is a pool of investment collected from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments. The combined holdings the mutual fund owns are known as its portfolio. Each share/certificate represents an investor’s proportionate ownership of the fund’s holdings and the income those holdings generate.
What are the various types of mutual funds?
There are primarily two types of mutual funds viz. open-end funds and closed-end funds:
Open-end Funds: An open-end mutual fund offers subscription and redemption of units on a continuous basis with no restrictions as to the total size and duration of the fund.
Closed-end Funds: Unlike open-end mutual funds, closed-end mutual funds sell a fixed number of shares at one time (in an initial public offering) that later trade on a secondary market such as the Pakistan Stock Exchange (“KSE”).
What are the advantages of investing in a mutual fund?
Equity markets in general and mutual funds in particular offer an attractive investment opportunity to both individual and institutional investors. While short-run prices of equities tend to be volatile, the long-term performance and returns on equity investments have been superior to other investment classes in most major developed and developing economies. Furthermore, a study of any ten year period in the last 100 years reveals that return on equities exceeds inflation rates, whereas return on deposits and on investment in debt related instruments has been below the relevant inflation rate. Thus, over time return on equity has produced positive wealth for investors, and households and businesses should, therefore, allocate a part of their savings to equities.
Major advantages of investing in mutual funds include:
Professional Money Management: Mutual funds give individual investors the benefit of experienced and skilled professional investment managers who have the knowledge and information necessary to make informed investment decisions. The fund managers devote themselves exclusively to monitoring market and economic trends, analyzing securities and implementing a consistent investment strategy that reflects the goals of the fund.
Diversification: Diversification is one of the best ways to reduce risk. By holding different assets – bonds, equities and cash – you reduce the risk of being in the wrong investment at the wrong time. Furthermore, diversification in different sectors, industries and companies lets you spread the risk by participating in many different parts of the economy.
Liquidity: Mutual funds provide liquidity. Investors can sell their mutual fund shares on any business day through the stock exchange in which it is listed and receive current market value on their investments.
Affordability: The minimum initial investment for a mutual fund is quite low for most funds. This allows investors to invest in various classes of securities through a single investment, thereby diversifying risk at a low cost.
Convenience: Mutual funds provide investors with detailed reports and statements that make record-keeping simple. Investors can easily monitor the performance of their mutual funds simply by reviewing the business pages of most newspapers.
How do mutual funds earn money for investors?
Investors can earn money from their investment in two ways:
Dividend Payments: A fund may earn income in the form of dividends and interest on the securities in its portfolio. The fund then pays its shareholders nearly all of the income (minus disclosed expenses) it has earned in the form of dividends. The price of the securities a fund owns may increase, resulting in capital gains. At the end of the year, most funds distribute the net capital gains to investors.
Increased NAV: If the market value of a fund’s portfolio increases after deduction of expenses and liabilities, then the net asset value (“NAV”) of the fund and its certificates/shares increases. In the case of closed-end funds, the higher NAV will be reflected in a higher share price of the fund, thereby resulting in capital gains for investors.
What are the tax implications of investing in a mutual fund?
Finance Act, 2010 introduced section 37(A), regarding the applicability of capital gain tax on securities including units of open ended mutual funds, in the Income Tax Ordinance, 2001 with effect from July 01, 2010 which states that;
“The capital gain arising on or after the first day of July 2010, from disposal of securities held for a period of less than a year, shall be chargeable to tax at the rates specified in Division VII of Part I of the First Schedule;
Provided that this section shall not apply if the securities are held for a period of more than a year;
Provided further that this section shall not apply to a banking company and an insurance company.(For insurance companies please refer clause 6B of fourth schedule of Income Tax ordinance, 2001)
Where a person sustains a loss on disposal of securities in a tax year, the loss shall be set off only against the gain of the person from any other securities chargeable to tax under this section and no loss shall be carried forward to the subsequent tax year.”
Provided that a mutual fund or a collective investment scheme shall deduct capital gains tax at the rates as specified above, on redemption of securities.