fundamentals january-june 2011

8/6/2019 Fundamentals January-June 2011

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F U N D A M E N T A L SSemi-Annual Magazine - Vol 5 (Jan - Jun 2011)

Call 0800-00026 SMS INVEST to 8258

www.UBLFunds.com [email protected]

Trust the Experts!

One SIP at atime: Smart

way ofgrowing

your wealth

Smart Ideasfor money

management

Islamic SavingOptions

Portfolio StrategyJan-Jun 2011


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F U N D A M E N T A L S

UBL Funds News

Launched in October 2010, UBL Savings Income Fund(USIF) is an open-end income scheme that is designed

for investors looking to earn a stable and competitivestream of income on their savings in the short tomedium-term. The scheme achieves this objective byinvesting in instruments such as Government securitiesand bank deposits.The scheme has given a return of11.58% p.a. since its launch.

Launched in November 2010, UBL Islamic Savings Fund(UISF) is an open-end Shariah-compliant income schemethat is designed for investors looking to earn Halalincome on their savings. The scheme invests in Shariah-compliant instruments including Islamic Governmentsecurities (such as Ijarah Sukuks) and Islamic bank deposits.The scheme has given a return of 11.84% p.a. since itslaunch.

UBL Fund ManagersLaunches two Income Schemes

In December 2010, UBL Fund Managers announcedadoption of the Global Investment Performance Standards(GIPS) for its funds performance reporting, becomingthe first Asset Management Company (AMC) in Pakistanto implement GIPS compliant reporting standards.

Developed by the CFA Institute, GIPS provide an ethical

foundation and self-regulated means to communicateperformance figures to prospective and current clientsso that they can make informed investment decisions.

UBL Fund ManagersFirst AMC to become GIPS compliant

09 One SIP at a time

Features

02 Smart Ideas for MoneyManagement

You get your salary at month end, what do you do next?Chances are that you let it lie in your bank account and

withdraw as and when you need it throughout the month.It may be hard to believe but for many of us, there is stillsome money left in the bank account at the time whenour next pay cheque arrives. The money resting in thebank earns no or negligible return.

13 Islamic Saving Options

The crux of Islamic investments is sharing of risk andexclusion of fixed or pre-determined interest products. InIslamic finance, profits only come at the cost of riskexposure but excessive risks and uncontrollable anduncertain obligations are also forbidden.

A follow-up of the article Portfolio Strategy publishedin the previous issue of Fundamentals, in this feature,Hasnain Raza Nensey, Chief Investment Officer (CIO), doesa performance review of the investment portfoliosrecommended for the last 6 months (Jun-Dec 2010) and

suggests new portfolio allocations and readjustments forJan-Jun 2011.

04 Portfolio Strategy 2011

Maleeha Bangash, Chief Strategy Officer (CSO), drawsfrom her international experience in the AssetManagement industry and explains the smart way ofgrowing your wealth one SIP at a time. When presentedwith a steaming, aromatic cup of tea, there are two waysto savor it - gulp it down at a go, or drink it sip by sip.Needless to say, the easier and immensely enjoyable waywould be one sip at a time. SIP is also the smarter way

for investors to grow their wealth.


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You get your salary at month end, what do you do next? Chances are thatyou let it lie in your bank account and withdraw as and when you need itthroughout the month. It may be hard to believe but for many of us, there isstill some money left in the bank account at the time when our next pay chequearrives. The money resting in the bank earns no or negligible return.

FUNDAMENTALS - Investor Magazine 02

By Asad Raza BhojaniManager UBL Pension Schemes

What about the return?

When your cash is lying in a current account of a bank, you donot earn any return on it. If instead, the cash is deposited in asavings account, you are likely to earn a return of around5-8% per annum. In the current interest rate environment inthe country, Money Market Funds are yielding a return between11-12% per annum.

The return on Money Market Funds is mostly tax-free (subjectto conditions), while individuals are taxed at a rate of 10% onthe return earned on a savings account. Additionally, an investoris able to reclaim up to Rs. 75,000 through tax credit by investingin these funds. This makes the overall return on Money MarketFunds considerably higher than that available by putting yourmoney in a bank account.

How can I get my money back should I need it?

Accessing your money through a Money Market Fund is easy.You do not invest for a fixed time period and the fundmanagement company is able to return your money along withthe accrued profit within three days of your request. Some

funds even offer a same day redemption facility to investors i.e.if you file a request to get your money back in the morning,

Welcome Money Market Funds

With little or no extra effort and just a little discipline, you canquite easily earn a decent return on your cash. This can beachieved through investments in what are known as MoneyMarket Funds (or schemes).

An investor should always ask three basic questions whenever

an investment proposal is presented to him or her; What aboutthe security of my capital?, What about the return? and finally,How can I get my money back should I need it? We presentthe answers to these questions for Money Market Funds througha comparison with your typical bank account.

What about the security of my capital?

A Money Market Fund invests a minimum of 70% of its assetsin securities issued by the Government of Pakistan. In terms ofcredit rating, these securities can be categorized as AAA. Thebalance is generally deposited with high quality banks with acredit rating of AA or better. On the other hand, in most cases,the bank that you maintain an account with would have a creditrating of A A or lower. Therefore, the security of your capital

through a Money Market Fund is better than that available withyour bank.


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Smart Saving Tips For Your Money

your account will be credited the same day. On the other hand,a minimum deposit period may be required to avail the ratesoffered by banks.

How to make the best use of Money Market Funds?

Now that we have determined why Money Market Funds are a

fruitful and safe medium to invest, we discuss two approachesthat investors could employ to make the best use of their idlecash.

For a regular saver

Suppose you earn Rs. 100,000 every month and through yourexperience you know that on average you spend aroundRs. 90,000 each month. At the time you receive your salary, youcan set aside Rs. 10,000 to be invested in a Money Market Fund.Such an approach would result in disciplined saving and alsogenerate a return on your cash that was effectively lying idlepreviously. Following this strategy, an investor would end upsaving Rs. 120,000 in a year and those savings would haveaccumulated a profit of around Rs. 7,150, assuming an overall

return of 11% during the year. Based on your income tax bracket,you could also receive a tax credit of Rs.12,000 for the year.

Of course, if you find yourself spending more than Rs. 90,000and need cash, you can easily withdraw from your investments.

For a non-saver

If you find yourself spending the entire Rs. 100,000 that you earnin the month, you could still generate a decent return on this

amount. It is unlikely that you would be spending the entire salaryin the first week of the month. So an alternative would be to setaside say Rs. 50,000 in a Money Market Fund as soon as youreceive your salary with the intention of withdrawing yourinvestments in the middle of the month when you would needthe cash.

If such a strategy is followed, whereby the individual is investedin a Money Market Fund for just 15 days every month, he wouldbe invested for a total of 180 days over the course of the year.Thiswould result in him/her making around Rs. 2,500 over the yearby just managing his/her money smartly.

Dont keep yourmoney idle - make itwork for you.

Keeping your money idle doesntearn you any return. Place yourcash in money market schemesto earn healthy returns with easy

access.

Unlock the potentialof your savings.

Invest your savings in incomeschemes, compared totraditional deposits they offercompetitive returns and no

Save taxes the legalway!

Invest your money in a mutual

fund scheme and get significanttax savings based on yourincome tax bracket.

Start investing early!

Dont make excuses - if youdont have a big amount toinvest, start with what you can

manage and try doing itregularly!


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For regular readers of Fundamentals, the Portfolio Strategy article needs no introduction. Fornew readers, this is where we recommend portfolio asset allocations for investors of different riskprofiles while also reviewing the performance of the portfolios we have recommended in the past.

Portfolio Strategy 2011By Hasnain Raza Nensey

Chief Investment Officer

Our recommended portfolios have generated impressive returnsand have benefited several readers who practically implementedthe strategies and came back to us with their success stories.

For readers who have yet to take the first step towards buildingtheir portfolio, there is no better time than now!

Lets begin by first reviewing the performance of the portfolioswe recommended for the last 6 months (Jul - Dec 2010). Thereturn generated by the 3 portfolios are given in the table below.After that, we move on to reviewing developments acrossvarious asset classes, and on page 6, we recommend freshportfolio recommendations for Jan-Jun 2011.

The recommended portfolios have performed well versus theinvestible asset classes - with the Aggressive and Moderateportfolios successfully capturing the buoyant mood prevalentin the markets during the period Jul-Dec 2010. The performanceof the conservative portfolio was relatively subdued, mainly dueto the weak performance from the Income Funds asset class.

Following is a snapshot of the returns generated by the portfolioswe have recommended since the time we started writing thisarticle in January 2009.

2-Year Absolute ReturnJanuary 2009 - December 2010

ConservativePortfolio

ModeratePortfolio

AggressivePortfolio

23.9% 40.5% 50.5%

Performance Review of RecommendedPortfolios

Equities

Fixed Income:- Term-deposits- Income Funds- GoP SchemesReal EstateCommodities (Gold)Cash (Money Market Funds)

21.87%

5.75%-1.67%6.25%1.09%

13.30%5.65%

Absolute Return(Jul - Dec 2010)

6-Month Absolute ReturnJuly - December 2010

ConservativePortfolio

ModeratePortfolio

AggressivePortfolio

3.8% 8.9% 12.3%

Individual returns (Jul-Dec 2010) for the asset classes that makeup the portfolios, are shown in the table on the top right.

04FUNDAMENTALS - Investor Magazine


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Return Vs Risk ofVarious Asset ClassesJuly - December 2010

The chart on the left shows how theportfolios we recommended for theperiod Jul-Dec 2010 achieved thedesired Risk / Return mix using theavailable asset classes.

Diversification in the portfolios helpedreduce risk and added to theportfolios return per unit risk.

Return versus Risk of various Asset Classes

0%

10%

20%

30%

40%

50%

0% 5% 10% 15% 20% 25%Risk

R

eturn(Annual)

Equities

Income Funds

Real EstateConservativePortfolio

ModeratePortfolio

Term deposit

AggressivePortfolio

Commodities

GoP Schemes

Developments across various asset classesand their future outlook

Equities

Risk: High | Return: High | Investment Horizon: 2Y 5Y

KSE100-index generated an absolute return of 21.9% duringthe period (1 July 10 to 28 Dec 10). The impressive returncompensated for the subdued performance of the asset classduring the prior six months (Jan-Jun 2010) when the return wasa mere 3.6%. The healthy consolidation in the earlier six monthsled to a strong rally in local equities, fuelled by growing foreigninvestor interest and healthy corporate earnings. The domesticequities are trading in-line with historic average PE (FY11E)valuation of 8.0x therefore we maintain our expectations fora 20% annual return from equity markets on the conservativeside. The systematic risk and uncertainties will continue to addnoise to the basic fundamentals; however, we have seen in thelast two years that over the long-term the price levels are dictated

by fundamentals rather than by the rumor-mill.

Global equity markets had corrected and consolidated duringthe prior six months (Jan-Jun 2010) and were poised to rallyduring Jul-Dec 2010. Investor sentiment regarding economicrecovery improved and money gradually shifted from risk-aversemoney market funds into risky asset classes like emerging marketequities in search of high returns. The developed marketsperformed better than emerging markets with S&P500 andFTSE both gaining 22% during the period. European marketsalso rallied as investor concerns regarding Greece subsided withDAX (Germany) and CAC (France) gaining 17% and 12%. Theperformance of major world indices can be summarized by theMSCI indices, where MSCI-ACWI (All Countries World Index)

and MSCI-EMI (Emerging Market Index) gained 22.5% and22.6% during the period Jul-Dec 2010 respectively. On valuationbasis, the regional peers as well as global developed marketsare trading in the PE range of 13x-16x. Therefore, Pakistaniequities trade at a significant discount to regional peers thiscan generate substantial foreign interest if Pakistans risk

perception improves.

Fixed IncomeRisk: Low | Return: Moderate | Investment Horizon: 6M 1Y

Term Deposits

At the time of publication of our last issue (6 months ago),rates for 6-month TDRs offered by A A category banks were inthe 10.75% - 11.5% (annualized) range. However, after therecent hikes in the discount rate and the State Bank of Pakistansshift towards a tighter monetary policy, the TDR rates have alsorisen to the 12.5%-13.5% range. The year-end deposit raisingefforts have also played a role in the improvement in TDR rates.The low risk nature of these placements, easy accessibility andexpectations of interest rate environment peaking out in the

near future justify some exposure in this asset class.

Income Funds

In the past year, Income Funds have come to be divided into twobroad categories, Aggressive Income Funds and Non-Aggressiveor simply 'Income Funds' - the differentiation between the twois in their portfolio constituents. While Income Funds generallyhave no exposure to corporate bonds (Term Finance Certificates,TFCs), aggressive income funds can have varying degree ofexposure to such long-term debt instruments. Since investorsthese days look towards a stable return from their income funds,we recommend investments in Non Aggressive Income Fundsthat are largely invested in Government Securities and high-yielding bank deposits and have no exposure to Term Finance

Certificates (TFCs) - thus reducing volatility in returns.

Government of Pakistan (GoP) Schemes

In our last issue, we recommended the National Savings Bonds(NSB) which yield a 12.5% p.a. for a 3-year instrument. Sincethen, State Bank of Pakistan has ordered primary dealers toprovide retail investors with access to direct investment intoT-Bills and PIBs. After the recent spate of monetary tightening,1Y T-bill and 3Y PIB yields currently stand at 13.65% and 14.15%p.a. respectively. Although accessibility to these instruments toinvestors may be limited at this point, they are our preferredchoice for investors who can invest in these instruments afterconsidering the tax implications with their investment advisors.

The aggressive portfolio has generated the highest return (50%);however this has come at the cost of higher volatility of about5.27% (annualized). The moderate portfolio offers slightly lowerreturn (40%) while reducing the volatility to a much moremanageable level of 3.27% (annualized). The conservativeportfolio reduces the volatility to a mere 2.5% (annualized) while

sacrificing return but still generating a much respectable 24%in the Jan - Dec 2010 period.

We have used annualized Standard Deviation as the measureof volatility. If you compare with the last issues, the volatility ofportfolios has declined this is the result of availability of longerhistorical data of portfolio returns which improves confidencein consistency of returns.

Cash


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Real EstateRisk: Moderate | Return: High | Investment Horizon: 10Y

Lack of transparency in the Real Estate market is a major obstaclein calculating Real Estate returns. We have estimated the returnof the asset class through inflation data collected by the Federal

Board of Statistics. According to the data, the Real Estate index(Building & Construction material) rose from 220.3 (Jun 2010)to 222.7 (Nov 2010), generating an absolute return of 1.09%during the period. However, the figure can be misleading as theactual volume of Real Estate transactions is very low due toliquidity constraints.

We recommended exposure in the Real Estate asset class witha long term view and we continue to believe that the asset classoffers exceptional value for long-term investors, especially as ahedge against inflation. Pakistans demographics, young,growing population and urbanization are the key factors behind

our stance on this asset class.

CashRisk: Low | Return: Low | Investment Horizon: 3M - 6M

We recommended Money Market funds for parking liquidity.These funds are structured to return yields similar to the prevailinginterest rate environment. Therefore, with the rise in discount

rate over the last month, the yield of this asset class has alsoimproved. The stable returns of these funds also provide a hedgeagainst the volatile nature of local capital markets.

Commodities (Gold)Risk: Moderate | Return: High | Investment Horizon: 1Y

Gold prices have gained from USD1,241/oz (Jun 2010) toUSD1,406/oz (Dec 2010) during the period, generating anabsolute return of 13.3%. Gold, and commodities in general,rallied strongly during the period as they are considered a hedgeagainst economic turmoil and currency volatility. Our earlierfears of high future inflation and devaluation of paper moneyresulting from the sharp increase in money supply due togovernment sponsored bail-out packages seem to be comingtrue. Simultaneous rise in prices of otherwise complementingasset classes such as Equities and Gold are a clear hint that thedriving force is the expected devaluation of paper money in

general.

GoP Schemes, 55%

Portfolio Recommendations for January - June 2011

Conservative Portfolio Moderate Portfolio Aggressive Portfolio

IncomeFunds, 30%

Cash, 15% Equities, 25%Cash, 10%

Income Funds,20%

GoP Schemes,20%

Real Estate,15%

Commodities(Gold), 10%

Income Funds,10%

Equities, 40%Cash, 5%

Commodities(Gold), 15%

Real Estate,15%

GoP Schemes,15%


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Benefits of investingin mutual funds

By: Colin Miranda, Research Analyst

The second column in the table indicates the return generatedby the two stocks, A and B, respectively in a particular year. Inthe third column, we see the return that you could realize if youwere to place all (100% of) your funds in Stock A; however,achieving this rate of return would expose you to a high levelof risk, and you would also have to carry out extensive researchin order to find stocks whose price would rise by 20% withinone year. Conversely, if you were to invest all (100% of) yourfunds in Stock B, you would suffer a loss of 8% on yourinvestment (as indicated in the last column). The middle groundis to distribute your investments across stocks A and B.

By dividing your funds evenly between the two stocks, you wouldattain a modest return of 6% while significantly reducing theoverall risk to which you would be exposing yourself.

Thus, diversification is the opposite of "putting all your eggs inone basket"; in the equity markets, this is achieved by purchasingstocks of a variety of companies in different sectors of theeconomy e.g. oil and gas production, banks, power generationand so on. In the debt markets, diversification can be attainedby spreading investments across instruments with different tenorsand instruments with different credit-ratings. Furthermore, bypurchasing units of a composite fund i.e. a fund that invests infixed-income instruments as well as equities, you can also achievecross-asset diversification. Doing this on their own for theindividual investor can be quite costly. However by investing inmutual funds, investors are provided with the immediate benefitof instant and cost-effective diversification and asset allocationwithout the large amounts of cash needed to create ones ownindividual portfolios.

Professional Investment Management

As mentioned earlier, in order to maximize the returns on yourinvestments, thorough research is necessary. However,conducting that research will most likely take up a significantamount of your precious time. All investment actions in mutualfunds are backed by thorough research that includes analysis ofeconomic trends, identification of sectors that are poised for

DiversificationOne of the primary benefits of investing in a mutual fund is thehigh level of diversification that can be achieved. Diversificationrefers to a technique that is often used by professional investorsto reduce the overall risk that is inherent in their investmentportfolio. Consider the table below:

Return 1 2 3

Stock A 20% 100% 50% 0%

Stock B -8% 0% 50% 100%

Portfolio Return 20% 6% -8%

Weights



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growth and picking stocks that are likely to rise in the future.Therefore, rather than having to spend vast amounts of timethoroughly researching every investment before you decide tobuy or sell, you have a mutual fund's research team who willmanage it for you. In addition, the need for professionalmanagement is acute when investing in volatile economic

conditions; the fund manager can adjust the funds allocationsand make it well-positioned to maximize returns in the timesahead.

The role of professional management comes to the forefront inthe case of fixed-income investments. Let's say you wish to takeadvantage of the high yield on corporate debt when interestrates are high. Since corporations rarely seek debt financing fromthe general public, the only way you can gain exposure tocorporate debt is to purchase units of a fixed income fund. Wheninterest rates decline, you could potentially realize a handsomegain on your investment due to the rise in prices of the underlyingTFCs (Term Finance Certificates).

Liquidity

Liquidity refers to the ease with which you can buy and sell financialinstruments. By contrast, units of mutual funds can be purchasedand redeemed with the utmost ease, which ensures that youcan enter and exit the market when they see fit or whenever theneed for cash arises. Some money market funds also offer asame-day redemption facility; such funds provide superior liquidity,allowing you to take out your money whenever you need it.Furthermore, Asset Management Companies that have strongbacking from a financially sound institution are capable ofredeeming your units even in the most dismal market conditions,thus ensuring that your liquidity needs are met at all times.

Convenience & FlexibilityMost mutual funds have a wide distribution net work, allowing

you to purchase units easily. In addition, once you have madeyour investment in the fund(s) of your choice, you can subsequentlyaccess your updated account information and transaction historyonline, usually at no extra charge. Furthermore, if you don't feel

the need for cash, you can choose to automatically reinvestdividends or capital gains on your investments; doing so wouldcompound the rupee-return on your investment.

As an added feature, most mutual funds allow you to shift yourinvestments from one fund to another. For instance, if you feel

that you could earn a higher return in the stock market than themoney market, you can instruct the Asset Management Companyto convert your liquid-fund units to stock-fund units.

Economies of ScaleWhenever you buy or sell a stock, you will have to pay a nominalpercentage of the value of the transaction as "brokerage" fee.Usually, the brokerage rate charged to individual investors is higherthan the rate charged to institutional investors, because theaverage volume of the individual investor's transaction issignificantly lower than that of an institutional investors.

By purchasing units of a mutual fund, individual investors canavoid the high transaction fees they would have had to pay if theywere to set up their own investment portfolios. Investors would

also save on the transaction costs they would have incurred whenperiodically adjusting their portfolio allocations.


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One SIPat a Time

The smart way forinvestors to grow their wealth

By Maleeha Mimi Bangash

Chief Strategy Officer

When presented with a steaming, aromatic cup of tea, there are twoways to savor it - gulp it down at a go, or drink it sip by sip. Needlessto say, the easier and immensely enjoyable way would be one sip ata time

A Cup of TeaGrowing one's wealth is akin to drinking a cup of tea. The twocommon routes to growing wealth are either making a lump-sum investment at a point in time, or the easier way of investingsmall amounts in a systematic manner, similar to consuming thatgratifying cup of tea, taking "one sip at a time" - that is, throughpredetermined small investment amounts at fixed intervals. Thelatter approach is widely practiced when we consider investmentsin mutual funds.

As far as investments and growing wealth are concerned, if dueto lack of substantial funds for one-time investment, buildingwealth is not a small savers cup of tea, then the most effortless

way to grow wealth is by opting for SIP.

What is SIP?SIP (short for "Systematic Investment Plan") refers to amethodology whereby investors decide to invest in mutual fundsthrough small investment amounts for which certain parametersand conditions are pre-decided. This includes the frequency ofinvestment i.e. monthly or quarterly, the amount (usually fixed)and the mode. Even though an investor can choose to makeinvestments on their own, the easier and more successful methodis to have the fund manager make an arrangement for regularinvestments into an asset allocation best suited to the risk appetiteof the investor, which ensures that the investors' needs andfinancial objectives are met in a timely manner.

Internationally, this arrangement is set up and executed by fundmanagers as an additional service to the investor. This is doneby the investor providing an explicit mandate to the fund manager.This mandate can be executed by the fund manager by meansof a Direct Debit from a bank account on a specified date, for aspecific amount which is then invested into the mutual funds.Alternatively, postdated checks can also be provided by theinvestor where preferred.

Benefits of SIP

Rupee Cost AveragingNearly all investors have heard that it is better to buy when the

prices are low and sell when the prices are high. However, thisremains an elusive method for the majority. Even highlyexperienced and prolific investors find themselves unable totime the markets effectively.

However, by investing a fixed sum systematically, at regularintervals, investments are made both at the highs and thelows. Over a period of time, there is an averaging effect whichbenefits the investor and makes timing the markets irrelevant.This is known as Rupee-Cost Averaging.

Power of CompoundingSIP allows investors to commence their investments with smallamounts and without experiencing a financial crunch, ascompared to lump-sum investments. If held over a period of



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As is evident, it is more beneficial for small ticket SIP investors tohave a longer investment horizon.

Convenience of SIP

The SIP technique introduces convenience to the investor. It

promotes financial discipline, allowing them to save and investregularly. It is an easy vehicle of investment that provides peaceof mind for small investors who find it difficult to keep constantvigil vis--vis the equity and debt markets. SIPs in mutual fundsleave wealth management to the experts, and provide the investorwith peace of mind. If the investor has the risk appetite to takea considered equity exposure, it is quite achievable to be able tobeat inflation in the long run.

SIP offers significant flexibility and can be tailored to suit theinvestors needs. Often fund managers allow the investor tochoose an investment amount and frequency, and vary thesewhen needed. If for some reason the investor misses theinstallment, the payment arrangement does not stop, and thereare also no charges for missing the installment. The SIP can be

time, this will generate continuous earnings in the form of profitsor dividends. When these profits are in turn ploughed back orreinvested, they help in exponential principal growth due to thecompounding effect.

This can be seen in the simple example below.

Suppose an investor decides to invest in a SIP, starting withRs. 5,000 and adding the same amount every month. In amoderate portfolio, with 50% investment in equity and 50% inthe money market, the returns would increase remarkably withthe investment time horizon. In five years, his principal wouldgrow by 41%; in ten years by 120%; and in fifteen years it wouldgrow to more than triple the principal amount invested. This ishighlighted in the chart below.

resumed as and when the investor is able to do so. Furthermore,the investment amount can be varied and profit redeemedanytime, without any extra charges.

Who should invest through SIP

Not only the salaried class but SMEs (Small & Medium Enterprises)

and small corporations can also potentially sign up for SystematicInvestment Plans. This avenue is ideal for people with medium tolong-term financial objectives. Medium-term objectives includegoing for pilgrimage, planning a vacation or buying a car; long-term objectives include a childs education and planning a childswedding. It is notable that SIP avenues are also available forShariah-compliant investment solutions.

International Popularity

Internationally, smaller ticket investors are increasingly movingtowards SIP as the ideal approach to building wealth.

A similar methodology is Dollar Cost Averaging, practiced widelyin U.S.A., where it is used to invest directly in the stock market.A fixed dollar amount is invested at regular periods of time, so

that shares are bought when prices are low and when prices arehigh. Thus, the average cost per share of investment is lower andover time, as the shares appreciate in value; the profits/gains arehigher which can then be realized by the investor at an opportunetime. The approach also reduces the risk of investing a largeamount when the shares are overpriced.

The example most pertinent to our savings and investment cultureis that of India, which has a considerable population of smallinvestors. Recent reports show that in 2010, 100,000 new SIPaccounts were opened, and the number of fresh SIP accountsshowed an enormous increase of 160% over the past one year.In India, non-metropolitan cities and micro investors (with amountsunder Rs. 1,000) are showing an increasingly greater interest inSIP. Market share for non-metropolitan investors has gone up

from 33% to 36%, and for micro investors from 13% to 16%.Also, according to a survey conducted in 2007, 75% of total retailinvestors were SIP investors.

Conclusion: "One SIP at a Time"

Due to the incomparable simplicity, ease, benefits and advantagesof SIP, it is clear that this methodology is a winner for small saversand investors. Through Systematic Investment Plans (SIP), investingand building wealth effortlessly over a period of time can becomeeveryone's cup of tea.

After5 years

After10 years

After15 years

Amount Invested:Rs. 300,000Portfolio Value:Rs. 422,000

Amount Invested:Rs. 600,000Portfolio Value:Rs. 1,220,000

Amount Invested:Rs. 900,000Portfolio Value:Rs. 2,725,000

Maleeha Bangash, Chief Strategy Officer, is an MBA in Investment and Finance from theUniversity of Chicago and has over 14 years of rich and varied international experience basedin Singapore, Pakistan, and Turkey in the areas of Investment Advisory and Finance.


Assumptions: Return on equity: 15% p.a., Return on money market: 9% p.a.


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By: Rahim Khakiani, Chief Financial Officer

Tax Savings

throughInvestments

As the global economy is struggling to get out of the currentrecessionary cycle, it has become a challenge for mostgovernments around the world to manage their public financeeither through increasing the revenues or by cuttingexpenditures. Since a major chunk of the government's revenue

come in the form of direct taxes, which is squeezed due todismal profitability of companies, thereby forcing governmentsto increase tax incidents on individuals.

Pakistan is of no exception, the nation recently faced a massivesetback due to unprecedented floods, which tested its emotionaland economic strengths. While it is arguable to gauge theGovernment's capacity to weather such eventuality in the future,the tendency is clear, which is to pass on the burden to thepopulation in despair. The very nature of the skewed tax structureof the country, with the tax base languishing at only around 2million registered tax payers out of a total population of 170million, many with considerable income at their disposal, do notpay taxes, eventually leaving the burden on the salaried class tomanage their taxes legally. The overall tax incidence on the

salaried class is also on the rise for quite some time as can beseen by the imposition of IDP taxes a couple of years back andmore recently when the threshold for maximum tax rate (20%)on salaried individuals was reduced from Rs. 8.65 million to Rs.4.55 million in the last budget.

Fortunately, Pakistani tax laws provide some relief to tax payersin the form of tax credits and rebates, however awareness ofsuch benefits remain low. If the tools for tax credit and rebatesare effectively utilized, they can bring annual savings of morethan Rs. 360,000 (total tax saving for 20% tax slab) for a hightier salaried individual drawing in excess of Rs. 4.55 million inannual salaries and other taxable benefits and more thanRs.132,000 (total tax saving for 10% tax slab) for individualsdrawing an annual salary of around Rs. 1.2 million.

The Finance Act, 2010 also removed the exemption available oncapital gains on listed securities including mutual funds, thoughthere are avenues open to minimize or avoid its incidence. Froma pure legal perspective, section 37A has been inserted in theIncome Tax Ordinance, 2001 to make way for capital gains taxes.

Though the income from this source is made taxable from thecurrent financial year, beginning from July 01, 2010, their incidencehas been kept low and only short-term capital gains are beingcharged to tax currently. As per the amendments in tax laws,individuals realizing capital gains with a holding period of lessthan 6 months have to pay 10% on such gains, while for aholding period of bet ween six months and one year, the samewould be taxable at 7.5% on such gains. For a holding periodof over a year, capital gains are not taxable.

The same tax principles are applicable on mutual funds, withthe only difference that the tax on capital gains on mutual fundsare subject to be withheld by asset management companies.An individual, while filing his/her return of income for that yearcan adjust the losses under this head and determine their final

tax liability. In case of any unabsorbed losses under this head,the same are not allowed to be carried forward to the subsequentyears.

As by now you are aware that capital gains are treated as aseparate block of income as defined in the income tax laws andare subject to maximum 10% on the gains, the tax incidence isstill very low considering the corporate tax rate of 35% andmaximum tax slab of 20% for the salaried individual.

While having considered the current tax scenario in Pakistan,lets take a look at how an individual investor can reduce his orher tax liability by investing smartly.



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An illustration to show how youcan get the most out of your

investments by availing taxsavings.

Lets consider the example of Mr. Hypothetical who earns an annual salary of Rs. 1.2 million. His profile is as follows:

Age: 35 years

Annual income: Rs. 1.2 million, growing @ 10% per annum

Annual expenditure: Rs. 0.84 million, growing @ 15% per annum

Current savings: Rs. 2 million, placed in a PLS Saving Bank Account earning interest @ 8% per annum

Annual donations to approved charitable institutions: Rs. 0.05 million

Annual mark-up on house loan: Rs.0.30 million

Investment possibilities:

His risk profiling determineshis asset allocation asfollows:

Equities: 25%Money Market: 75%

Estimated Return:

For Equities: 25%For Money Market: 12%Overall Return: 14%*

* Weighted Average Return onInvestments

His savings can be placed in bank deposits, in mutual funds and pension fundsin accordance with his risk profile and financial planning can be done based on thefollowing scenarios:

Annual Income 1.2

0.96

2

Rupees in millions

Annual Expenditure

Current annual savings

Current net worth:

Bank account

Equity funds

Money market funds

Tax credits and rebates:

Mutual funds

Pension funds

Markup - house loan

Charitable Institution

Investment value:

After 5 years

After 10 years

After 15 years

1.2 1.2

0.96 0.96

0.24 0.24

0.5 0.5

1.5 1.5

2 2 2

0.012

0.024

0.030

0.005

0.071

4.840 6.273 6.784

7.452 13.039 14.572

6.149 20.477 24.062

-

-

-

-

-

-

-

-

0.24

-

-

-

-

Scenario 1

He continues with

his current savinghabit by placingthe money in

PLS SavingAccount @

8% per annum.

Scenario 2 Scenario 3

He invests in

mutual funds andpension funds asper his risk profile

with taxcredit / rebates.

He invests in mutual

funds and pensionfunds as per his riskprofile without

claiming taxcredit / rebates.


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Islamic Saving OptionsBy Wahaj Aslam

Fund Manager - Siraj Islamic Funds

Islamic banking has seen some vibrant years in recent pastwhereby it received due recognition with a commendable doubledigit growth. Investors globally hold more than $1.5 trillion inShariah-compliant investments and there are more than 500funds globally that comply with Islamic principles, of which one-third of the funds were launched during the past four years - thefigure is projected to double in the coming five years. This isdespite the fact that the demand for Islamic products is stilloutpacing the supply, and there a dearth of education and trainingfor Islamic investment managers and Shariah scholars.

Islamic Finance Products fall into two broad categories - thosethat have the characteristics of Equity and those that have the

characteristics of Debt. Equity products are considered "more"Shariah-compliant since these promote the Shariah principle thatreward should come from sharing the risk of a venture.Nonetheless, debt products do have a place in the modern Islamicfinance industry - e.g. Profit and loss sharing bank accounts.

Islamic Equity FinanceInvestment in shares of a company (without the element ofspeculation or intra-day trading) is de facto Shariah compliantsince Islamic finance values equity partnership as the ideal methodof investment as long as the underlying business is compliantwith the screening criteria. However, investors are prohibitedfrom investing in preferred shares of stock due to the guaranteedrate of profit they entail. Islamic equity funds have experienced

tremendous growth and have proved to be an attractiveinvestment vehicle for investors looking for Islamic modes ofinvestment.

The crux of Islamic investments is sharingof risk and exclusion of fixed orpre-determined interest products.In Islamic finance, profits only come at thecost of risk exposure but excessive risksand uncontrollable and uncertain obligations

are also forbidden.

Investment Screening Criteria

1) Business of the investee companyThe business of the investee company should be Halal.Accordingly, investment in shares of conventional banks,insurance companies, leasing companies, Modarabacompanies, companies dealing in alcohol, gambling

etc. are not permissible.

2) Debt to total assetsThe total debt of the investee company should notexceed 40% of the total assets. The debt here includesall interest-based debt & interest based financing.

3) Illiquid to total assetsThe total illiquid assets of the investee company as apercentage of the total assets should be at least 20%.

4) Investment in non-Shariah compliantactivities and income from non-Shariah

compliant investmentsThe total investment of the investee company in non-Shariah compliant business should not exceed 33% ofthe total assets. The income from non-Shariah compliantinvestment should not exceed 5% of the gross revenue.Subsequently, giving the proportionate portion of non-compliant income to charity is required to purify thedividend income from these stocks.

5) Net liquid assets versus share priceThe net liquid assets per share should be less than themarket price of the share. [Net Liquid Assets = TotalAssets - (Tangible Fixed Assets + Inventory) - Liabilities]



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Islamic Debt Finance (Deposits)Profit and loss sharing (PLS) is the ideal business form in Islamicfinance since it promotes equity and the sharing of risk andreward (partnership is highly regarded in Islamic financial Fiqh)between parties. There are t wo main forms of partnerships inuse namely Modaraba and Musharaka. These two structures areused by Islamic banks in savings accounts.

Islamic banks offer two kinds of deposits: Current accounts andInvestment accounts. Current accounts are similar to those offeredby conventional banks. The deposited capital is guaranteed andmade available to the client at any moment whereby no rewardor return is paid on deposits. They are mainly used for transactionand safety purposes and deposits are accepted on the conceptof Qard / Loan.

In contrast, Investment deposits or conversely Term Depositsbased on the principles of Partnership (Modaraba or Musharaka)must remain with the bank for a certain, previously agreed,period (majority of Islamic Financial Institutions have nowsuccessfully launched PLS daily product deposits). Investmentaccounts are based on trust financing. The depositor is the

financing partner, while the bank is the managing partner. Thebank pools all investment deposits and searches for suitableinvestment opportunities. The return on investment (positive ornegative) is then shared with the depositors, after the bank hasdeducted its own costs and a previously agreed fee for its efforts.In the event the investment is not profitable, the depositors sharethe loss. Their maximum liability is the deposited sum. Investmentdeposits can only be withdrawn prematurely by paying a certainfine.

Modaraba

A Modaraba is a silent partnership between investors, orsleeping partners (known as the rabb-al-mal) who provide

capital to an agent (the mudarib) who acts on their behalfand invests the capital on behalf of the investors. Theinvestors and the agent share the profits of a venture (ifany) according to a predetermined ratio. The mudarib mayonly use the funds for purposes that are explicitly definedin the contract. At the conclusion of the Modarabatransaction, the mudarib must return the principal and thepredetermined share of profit to the investors.

MusharakaThe Musharaka is a full contractual partnership formed topursue a specific line of business or project. The projectcan be a new venture or an exist ing one that requiresadditional capital. In contrast to the Modaraba, a Musharakaallows each partner to contribute capital (i.e. each partnerin the Musharaka receives an equity stake in the venture)and to jointly share in the profits and losses of the venture.Another key difference between the two contracts is thatin the Musharaka each partner not only contributes capital,but also contributes some amount of labor.

Murabaha (Cost Plus)

This concept refers to the sale of goods at a price, whichincludes a profit margin agreed to by both parties. Thepurchase and selling price, other costs and the profit marginmust be clearly stated at the time of the sale agreement.The investor is compensated for the time value of its moneyin the form of the profit margin. This is a fixed-income loanfor the purchase of a real asset (such as real estate or a

vehicle), with a fixed rate of interest determined by theprofit margin.

When considering Islamic investment options, the followingsummarizes the saving options available in the market place:

Islamic Certificates of InvestmentsCertificate of Islamic Investment are offered by Islamic banks invarious tenors ranging from one (1) month to five (5) years. Inthe prevailing environment, the average rate for a tenor of 6-

months and an investment of below Rs. 10 million is around7.62% p.a.

Sukuk (Islamic Bonds)Sukuk, one of the most popular investment instruments may beunderstood as a Shariah compliant 'Bond'. In it s simplest formSukuks represent ownership of an asset and not just a claim tothe cash flow.

A Sukuk can be of many types depending upon the type of Islamicmodes of financing and trades used in its structuring. However,the most important and common among those are Ijarah, Shirkah,Salam and Istisna. Ijarah Sukuk is the most popular structure andhas been recently launched by the Government of Pakistan aswell. These Sukuks represent ownership of equal shares in a

rented real estate, right to receive the rent and dispose of theirSukuk in a manner that does not affect the right of the lessee,i.e. they are tradable. The holders of such Sukuks bear all cost ofmaintenance and damage to the real estate. Ijara Sukuks issuedby the Government are now available to individual investors aswell since the State Bank has instructed banks to offer "InvestorPortfolio Securities Account (IPS)" to its clients.

Real EstateInvesting in real estate is fundamentally one other permissibleform of Islamic investment. Therefore, buying, maintaining,leasing, and selling real estate via which an income is generatedis acceptable in the eyes of the Shariah. Real estate and propertydevelopment is a key industry in the Middle East, the Arab world,

and the Muslim world which requires a substantial amount ofcapital and may not be feasible or efficient for many investors.Consequently, investing in a Real Estate Investment Trust (REIT)is a more suitable option.

Real Estate Investment TrustA REIT is an entity that invests in different kinds of realestate or real estate related assets. The properties can beof a residential nature, or be commercial real estateproperties, such as offices, hotels, and malls.

Shariah Advisory Board"Shariah Advisor y Board (SAB)" is a regulatory body thatsupervises and ensures that the Islamic financial institutionsperform their operations according to the Islamic law. Shariahsupervision and approval is the main differentiating factorbetween a conventional and an Islamic instrument. An SABcomprises of appropriately qualified scholars to determinethe relevant rules for financial transactions. Ideally the roleof a Shariah advisor comes into play from the time ofdevelopment of an Islamic product or service, to its launchand throughout the period it is offered. The Board providestheir opinion on compliance by issuing a Fatwa (an Islamic

legal opinion) which is a stamp of approval for an Islamicinvestment



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It takes 20 years to build a reputation and five minutes

to ruin it. If you think about that, youll do things differently.

Warren Buffett

GlobalInvestmentPerformanceStandards(GIPS)

By Aly OsmanHead of Compliance &Internal Audit

Performance is an investment managers calling card. It is whatkeeps clients and wins new ones. The ability to promote a firmsperformance is a competitive necessity and equally essential isthat clients and prospects can also trust the integrity and fairness

of a firms performance claims.

That is why the CFA Institute implemented the Global InvestmentPerformance Standards or GIPS. Based on the underlyingprinciple of full disclosure and fair representation, GIPS is justwhat the name implies - a worldwide set of standards formeasuring, calculating, and reporting investment returns.

Advantages of GIPS Compliance

Institutional investors now require their portfolio managers in theinternational markets to be in compliance with GIPS and ofteneven require verification of GIPS compliance by an independentparty, thus making GIPS the international best practice inperformance reporting.

There are two major advantages to complying with GIPS andgetting third-party verification. One is the additional credibilitythe claim of compliance brings to performance numbers in salespresentations, advertising, media relations, and marketingliterature. This added credibility can help reinforce existing clientrelationships and open doors to more potential clients. A secondadvantage is that GIPS compliance provides a framework thathelps strengthen a firms internal control structure. Processes runsmoother and portfolios are managed more cohesively as a resultof established policies and procedures.

GIPS Compliance requires Firms to learn the GIPS standards,implement new processes and controls, and understand theintricacies of creating port folio composites. This initiative requiresan investment of time, labor, resources, and commitment. Theprice of GIPS compliance, however, is far out weighed by thepotential costs of noncompliance that may be fewer growthopportunities, damage to a firms reputation by not keeping upwith the industry international best practices, and ultimately, lostbusiness.

15FUNDAMENTALS - Investor Magazine


19/20

Non-compliance with the standards may suggest a weakercommitment to ethical standards or weak internal controlsinsufficient to claim compliance. If performance measurementcontrols are not a best practice this may be an indication thatother controls within the firm are weak.

Investors should require their managers claim compliance withGIPS; it is really a question of basic hygiene. If firms do not claimcompliance either:

- their controls and procedures are so weak they cannot achievecompliance, or;

- they are ignorant of the standards or not yet convinced of thebenefits

For asset managers the advantages are less obvious and of coursethere is the cost of compliance to be offset, however the followingadvantages significantly outweigh the cost of GIPS compliance.

- Competitive Advantage- Level Playing Field International Passport- Increased Professionalism- Risk Control- Business efficiency and data quality

The advantages of GIPS for investors are obvious; they can selectasset managers based on good quality information withconfidence that the performance numbers presented are a fairand honest representation of that firms track record as well asbeing consistent, comparable and transparent. GIPS Standardsprevent firms from:

- Cherry picking of accounts/portfolios or time periods- Use of inappropriate benchmarks- Inadequate disclosures

Creating and Managing Composites

The key provision of GIPS is the requirement to include all of afirms fee-paying, discretionary portfolios in meaningfulcomposites. Creating composites is the crucial first step towardsGIPS compliance. Firms that are contemplating GIPS compliance

will need to set up composites and have a system in place formanaging them well in advance of actually claiming compliance.

Composites are aggregates of portfolios that share commoninvestment objectives or strategies. The composite return is theasset weighted average of the returns of all the portfolios in thecomposite. The goal of composites is to ensure apples to applesperformance comparability from one firm to another and preventcherry picking of only a managers best performing accounts.

Constructing and maintaining composites is perhaps the secondgreatest challenge and the one that consumes a lot of time andresources in GIPS compliance, while formulation of GIPS PolicyFramework is probably the foremost challenge in achieving GIPScompliance.

Managers need to define composites, select portfolios correctly,and deal with portfolios that do not fit neatly into compositesavoiding too many overly narrow composites or too few overlybroad, meaningless composites.

Conclusion

Adhering to the GIPS standards is in the best interest of anyinvestment firm that wants to compete effectively and fairly. Ithelps the firm to build a framework for implementing industryinternational best practices, while providing a competitiveadvantage. Most significantly, it helps engender trust on the partof clients and prospects.


20/20

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Disclaimer: Information presented in this magazine was prepared basedupon information believed to be reliable and is not guaranteed by UBLFund Managers to be accurate, and should not be considered to be all-inclusive. This magazine contains forward-looking statements that

involve risks and uncertainties. This material is for informational purposesonly and should not be construed as an offer or solicitation to buy orsell securities. This information is in summary form and does not purportto be complete. It is intended as a general guide and is not a substitutefor professional advice. The information does not take into accountyour personal needs and financial circumstances and you should considerwhether it is appropriate for you.

FUNDAMENTALS is a semi-annual magazine for existing and potential clients of UBL Fund Managers.

Date of print: January 13, 2010

You can also follow us on twitter: www.twitter.com/UBLFunds

fundamentals january-june 2011

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