Mutual Fund is a fund created by pooling the savings of a number of investors who share a common financial goal (growth, income, risk diversification, others). The term “Mutual” implies that fund belongs to all the investors. The general benefits offered by mutual fund over stock investment by individual are the ease of diversification, expert handling of the investment decisions, collective bargaining power, lower transaction costs and high liquidity among others. 

 

Growth funds are aimed to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities and thus have comparatively high risks. The income funds aim to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, government securities, dividend paying securities and money market instruments. These are less risky as compared to the growth funds but also have relatively lower expected returns. The aim of balanced funds is to provide both growth and regular income. 

 

In the context of Nepal, the history of MF started with the floatation of NCM Mutual Fund, 2050 – an open ended fund with an amount of 100 million and managed by NIDC Capital Markets Ltd. 

 

SEBON set provisions to make the issue prospectus more transparent. It also prescribed for inclusion and acceptance of investor friendly provisions, which included the autonomy of the fund, the fund manager and the custodian with their clearly defined roles and transparency in the valuation of assets. Besides it mandated that fund should bring earnings cum growth schemes (not growth scheme alone) and that sponsor should bring in at least 15% corpus to the fund. However, clear mandate to regulate such a fund was not available to the SEBON and existing legal frameworks too were not sufficient. 

 

But, after two years of operation, the NCM Mutual Fund could not cope with the liquidity pressure generated by the fund holders and, NRB and Nepal Industrial Development Corporation had to help it out. Citizen Unit Scheme, 2052 and NCM Mutual Fund, 2059 followed. The latter scheme, upon maturity was not able to repay unit holders on time. 

 

SEBON observed the necessity of drafting an Investment Trust Act to enable the establishment and operation of trust funds and thus the Securities Investment Trust Act of 1997 was enacted. 

 

Currently, two most active mutual funds schemes in the market are: Siddhartha Investment Growth Scheme – I (SIGS-I) and Nabil Balanced Scheme – I (NBS-I). SIGS-I is a growth scheme, thus exhibits higher volatility and higher expected returns. And NBS-I is expected to exhibit relatively lower volatility and lower expected returns. 

 

These funds invest in stocks, bonds and money market instruments. For stocks, the funds have to rely on the Nepalis stock market and the initial public offerings. 

 

The Nepalis stock market is characterized by low liquidity, high concentration and volatility. The investors too are not knowledgeable and trade infrequently- further hampering the liquidity. The investors demonstrate herd mentality, and trade on noise rather than on fundamentals. The capital market is concentrated in BFIs and insurance companies. Only few hydropower companies, a telecom provider and few manufacturing companies offer some sort of diversification. 

Technology is also seen as a major issue. Transactions take long time to materialize. Technology to calculate real time NAVs is missing. Conflict of interest is persistent within the fund, between the schemes, and with the funds and the banks that sponsor them. If a fund operates multiple schemes (there is a rumour that Sidhhartha Capital is trying for this), then how will the costs of transactions be allocated across the schemes? 

 

For example, if ABC Mutual fund is operating three schemes – growth, balanced and income and suppose all the schemes have to buy shares of Sanima Bank. If the combined requirement is for 1000 shares, then during the purchase, the cost for the first share and the thousandth share mayn’t be the same. Then, in such cases, how will the fund allocate the cost across the schemes? How will the managers be remunerated if they are involved in management of all the schemes? Wouldn’t they be induced to overwork on schemes that provide better incentives, thereby hampering the performance of other schemes? 

 

Also, investors can hardly get neutral advices regarding the funds from the sponsor banks. Suppose a person has fixed deposit at Nabil Bank. Upon maturity, if the depositor asks the bank for suitable investment prospects, would the bank official discuss the advantages of both SIGS-I and NBS-I or only of the latter? 

 

A lot of increase in NAV of the mutual fund schemes currently in action, particularly that of SIGS-I can be attributed to the prescribed allocation in IPOs. A set portion of IPOs is distributed among the mutual funds, thereby enabling the funds to post high increase in scheme NAVs. How will these schemes deliver in periods of no IPO offering is yet to be seen. 

 

We tried to study the performance of Indian Mutual Funds since 1962. We studied this to identify problems faced by them in the past and the present, and their prescribed solutions. This would help better predict the future of Nepalis Mutual Fund industry and thus help us prepare for it. Assessing the Indian MF industry, diversification, investor literacy, penetration to rural areas and smaller towns, conflict of interest, ambiguity of law, lengthy procedures and lack of customer focus on products were seen as past and prevalent problems. Although different segments of the industry were working on resolution, the problems did form the bottleneck in the rapid growth of the industry. 

 

Similar problems, apart from the existing ones, are expected in Nepal over the next decade. Liquidity, volatility, transparency, investor literacy and system related problems will take time and immense effort to be resolved. All the parties involved in the industry have to play active role in resolving these issues in order to help the industry grow. Solutions could be home grown or inspired by the global best practices fitting the Nepalis market. 

Apart from these problems, the concentration of Nepalis stock market in banking, financial institutions and insurance company stocks make it harder for mutual funds to generate a finely diversified fund. 

 

Resolving these issues would ensure bright future of mutual fund industry in Nepal, at least for the next decade until Exchange Traded Funds (ETFs) replace them. 

 

The article is based on the executive summary of the project work on mutual fund carried out as a part of ‘Investment Management’ course at KUSOM. The project work was jointly carried out by Suraj Bansal, Ujjwal Chand, Monika Maheshwari and Ashish Naulakha.