Project Proposal

Investment Management

Performance of Mutual-Funds Industry in Pakistan & the Impact of

Option Hedging

Muhammad Kamran Danish

VU ID: mc070400254

Virtual University of Pakistan

Submitted To:
Instructor (FIN-619)
Project Management Department FIN-619

Date of Submission: 31st October, 2009

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 Table of Content

Chapter 1....................................................................................................................................3
.a Background: ................................................................................................................3
.a Introduction of the project: .........................................................................................4
.a Research Objectives.....................................................................................................6
Significance of the Study: ..............................................................................................6
Chapter 2: Project Proceedings..................................................................................................7
Chapter 3: Methodology............................................................................................................7
.a Data Collection sources: ..............................................................................................7
.a Data Collection Tools: .................................................................................................7
.a Data Processing: ..........................................................................................................7

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Chapter 1

.a Background:
Investment management is a very competitive business with many different types of service
providers. Increasing numbers of financial and non financial companies now declare savings
and investment products and services to be their core competence. A number of factors have
made investment management one of the fastest growing and competitive businesses in the
financial services industry. These factors include tremendous growth in assets under
management, the globalization of capital markets, and the proliferation of investment
alternatives, changes in client demographics and relationships, and rapid technological
advancements.
Investment management is the professional management of various securities (shares, bonds
etc.) and assets (e.g., real estate), to meet specified investment goals for the benefit of the
investors. Investors may be institutions (insurance companies, pension funds, corporations
etc.) or private investors (both directly via investment contracts and more commonly via
collective investment schemes e.g. mutual funds or Exchange Traded Funds).
A mutual fund is a professionally managed type of collective investment scheme that pools
money from many investors and invests it in stocks, bonds, short-term money market
instruments, and/or other securities. The mutual fund will have a fund manager that trades the
pooled money on a regular basis. The net proceeds or losses are then typically distributed to
the investors annually
Mutual Fund, otherwise known as an investment company, is a corporation, which pools
together investor’s money generally to purchase stocks and bonds. Investors participate in the
Mutual Fund by purchasing shares of the entire pool of assets, thus diversifying their
investment. Professional managers who buy and sell securities on behalf of the investors
invest the pooled assets. Because Mutual Funds pass all gains, losses and tax
obligations/benefits through investors, they receive preferential tax treatment.
In an environment where investors and savers lament the lack of investment options, financial

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Savings in the economy do not show an encouraging growth pattern, and a minimum rate of
return on savings deposits has been implemented by the central bank to encourage savings,
the exponential growth of mutual funds in recent years has served to meet these very needs
by mobilizing savings and providing lucrative investment options to both retail and
institutional investor. There are two basic types of Mutual Funds, Closed-ended and Open-
ended. Further classification can be made with loads and no-loads. Again based on
investment objective it can be further classified into: - 1) Growth funds 2) Income funds 3)
Balanced funds 4) Money Market funds 5) Tax Savings funds 6) Specialized funds and 7)
Assured Return funds etc.
Many people purchase Mutual Funds because they are a convenient and cost effective
method of obtaining diversification and professional management. Investors can invest the
money in stocks, bonds, short-term money-market instruments, other securities or assets, or
some combination of these investments; hence spreading the risk over a number of
investments. Additionally, Mutual Funds generally buy and sell securities in volume, which
allows investors to benefit from lower trading, management and research costs. Another
advantage the Mutual Funds offer is that fund performance is subject to frequent reviews by
various advisors and rating agencies, making it possible for investors to conduct direct
comparisons between funds.

.a Introduction of the project:

Although much research has already been conducted on mutual funds on various markets of
the world, its performance has yet to prove its tests in Pakistani mutual fund market. This
paper studies the performance of the mutual funds in Pakistan as tested against its individual
characteristics like past performance, fund flows, portfolio size and proxies for expenses and
trading activities. Each of these characteristics implies different management techniques that
contribute towards the good or bad performance of the mutual funds. Hence, this also

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highlights the managers’ role in fund performance and its relationship with the high or low
fund fees.

Three different types of mutual funds have been selected i.e. open – ended mutual funds,
closed – ended mutual funds and index fund, which would be tested against the common
characteristics. They are observed with an objective to educate the laymen investors to
understand the severity of different characteristics on different kinds of mutual funds. The
data selected for this purpose is of past 5 years i.e. from 2003 to 2007. Reason being that the
Pakistani mutual fund industry does not have a deep history; hence, the data beyond this
timeline could not participate in achieving our research objectives.

It is evident from the previous studies that Jensen’s linear regression model (also known as
Carhart four factor model) provides a better base for analyzing the impact of many
independent variables on a single dependent variable (i.e. in this case returns of mutual
funds). Hence, I have used the multiple regression model – a concept from Jensen’s linear
regression model – in my studies for the performance evaluation of Pakistani mutual funds.

The increased interest of investors in the mutual fund industry of Pakistan is evident from the
increased number asset management companies are being listed in the stock exchange along
with the increase in number of funds. Market capitalization of the funds has also grown
tremendously.

The title of the project is Performance of Mutual-Funds industry In Pakistan & the
Impact of Option Hedging. My research is distributed in two parts. The first part is the
analysis of relationship of mutual funds’ attribute with the funds’ returns. Whereas the second
part deals with the analysis of the impact of option hedging tool.

Purpose of Study

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 • Whether funds’ total net assets, net fund flow, administration fees and commission
have a direct impact on the returns of Pakistani mutual funds?

• Whether Option Hedging could have prevented the demise of Pakistani mutual funds
in year 2008.

.a Research Objectives

Following are the objectives of my study:

• To conduct In-depth analysis of mutual fund industry in Pakistan and of Put Stock
Option Hedging strategy.

• To analyze the impact of the following fund attributes on Pakistani mutual funds’
performance grouped in equity, Balanced and Income funds.

o Funds’ Returns from 2003 to 2007.

o Funds’ Size as Total Net Assets.

o Net Fund flows in the funds.

o Funds’ Administrative fees.

o Funds’ brokerage Commission.

• To apply the strategy of Portfolio Insurance through Put Option Hedging in order to
analysis the impact on the actual returns of open – ended equity funds in year 2008.

1.4 Significance of the Study:

The increased interest of investors in the mutual fund industry of Pakistan is evident from
the increased number asset management companies are being listed in the stock exchange
along with the increase in number of funds. Market capitalization of the funds has also

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 grown tremendously. My research will helpful to understand the mutual fund market
mechanism in two parts. The first part is the analysis of relationship of mutual funds’
attribute with the funds’ returns. Whereas the second part deals with the analysis of the
impact of option hedging tool.

Chapter 2: Project Proceedings

Part 1: INTRODUCTION
Part 2: LITERATURE REVIEW
Part 3: MUTUAL FUNDS INDUSTRY PERFORMANCE
Part 4: OPTION HEDGING STRATEGY
Part 5: ANALYSIS OF PAKISTANI MUTUAL-FUNDS
Part 6: MUTUAL FUND HEDGING IN YEAR 2008
Part 7: CONCLUSION & RECOMMENDATIONS

Chapter 3: Methodology
.a Data Collection sources:
The data is obtained through both primary and secondary sources. The data for fund attributes
is collected using quarterly and annual reports of the funds.

.a Data Collection Tools:

The data gathered through secondary sources will be analyzed by quantitative methods
Conclusion and analysis will be included in the report. The mathematical tools like graphs,
charts, and diagram will also be used for the deep and comprehensive analysis of the data.

.a Data Processing:

The nature of this study is Quantitative and Descriptive. I have done the analysis of impact of
fund attributes on the return of each individual Pakistani mutual fund from year 2003 to 2007.

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In this study, the correlation is determined by using the Multi-variable regression model. In
order to run the regression on different variables, E-Views software has been used. Put Stock
Option Hedging strategy has been implemented in year 2008 against the actual returns of the
Pakistani mutual funds in order to see the impact of “Portfolio Insurance”.