Mutual Funds: Financial Reporting and Internal Controls Day 1

1
Mutual FundsFinancial Reportingand Internal
ControlsDay 1

• Presented by
• Altaf Noor Ali
• Chartered Accountant

2
Mutual FundsFinancial Reportingand Internal
Controls

• Keynote address by
• Mr. Nasim Beg
• Chairman, Mutual Funds Association of Pakistan
• CEO, Arif Habib Investment Management Ltd
• and a Chartered Accountant

3
Day 1 9.30 am 5.00 pmMutual Funds Financial
Reporting

• Mutual Funds as investments
• MF Financial Reporting Framework
• MF Model Financial Statements Review
• MF and benchmarks
• MF Internal financial reporting

• Session Objectives
• Outline the present scheme of external financial
  reporting.
• Discuss ideas about improving it.
• Outline internal financial and non-financial
  reporting.

4
Tell us about yourself

• Let us melt the ice with an introduction.
• Tell us
• Your name and education
• Your position, department organisation
• Duration in present position
• Your most important function
• Feel free to express yourself in a language of
  your choice that we understand.

• About the Speaker
• I am a practicing chartered accountant.
• My first introduction to mf was in UK in 1992 as
  an independent financial consultant.
• Thereafter, in Pakistan, my earliest investment
  in a mutual fund was in 1995 and since that time
  I have keenly observed the evolution of mutual
  funds in Pakistan as an active investor and
  critic.
• As a speaker, I believe training is boring but
  learning is like LG KG 195 - full-time masti
  non-stop fun.

5
Group Activity Mutual FundsFinancial
Reportingand Internal ControlsLet me have the
Questions on Your MindDuration 5 minutes

• Lets start by noting relevant questions and
  issues that you believe we must be covering in
  our session
• Example What are the five most critical issues
  in preparing financial statements of mutual
  funds?

6
Mf Financial Reporting and Internal
ControlsKey Questionsgt

• Who are the main stakeholders in mf?
• How is financial reporting for mf different from
  other business entities?
• Do users actually go through the financial
  reporting?

• What is the best measure for evaluating
  performance of a mf?
• What is the role of regulators in improving
  financial reporting of mf?
• Why mf are not so popular in Pakistan?

7
Mf Financial Reporting and Internal
ControlsKey Questionsgt

• Name the best Fund available right now?
• What are the major issues in internal control of
  an asset management company?
• Is it possible to comprehensively discuss this
  topic in the alloted time?

• Is it possible to make the financial reporting
  external and internal more meaningful?
• What is the point of holding this session?

8
Mf Financial Reporting and Internal
ControlsUser Issues and Perceptiongt

• Is the financial reporting of mf done with user
  in mind?
• Every bank now appears to have an asset
  management company of its own. What should be
  done to resolve conflict of interest in such
  situation?

• Is it true that the mf are managing their equity
  portfolios much more actively than in past? As a
  result, they trade on day to day basis and KSE is
  much more volatile than before because of limited
  float.
• Should there be a separate financial reporting
  standard for mf?

9
Course Organisation

• Session 1 Overall view of mf
• Session 2 Financial Reporting
• Session 3 Internal Controls and Fraud Prevention
  in mf
• Session 4 Review and Conclusion

• Course Objective
• Discuss the financial reporting practices and
  practical issues in financial reporting. Provide
  an outline for possible solutions.
• Sharpen our understanding of operational
  internal controls of mf. Focus on investment
  policy, its interpretation, application, and
  controls.

10
mf basic business model

• A mutual fund is a collection of stocks, bonds,
  or other securities purchased by a pool of
  investors and managed by an asset management
  company.

11
Mutual Funds Classification

• Close-end Funds
• Open-end Funds
• Additional Notes
• Employee Provident Fund, and Pension Schemes are
  also a kind of mutual fund managed by trustees on
  behalf of members.

• Income
• Equity
• Balanced
• Index Tracking
• Islamic Income, equity and balanced
• Sector
• Fund of Funds
• REIT
• Pension Funds

12
Mutual Funds in Pakistan Major Players

• Asset Management Companies
• NIT
• JS
• PICIC
• Almeezan
• AKD
• Arif Habib
• Atlas
• BMA
• PICIC
• BMA
• Askari
• IGI
• National Fullerton
• Dawood

• How Mutual Funds have evolved in Pakistan?
• Investment Corporation of Pakistan and National
  Investment Trust were pioneers in establishing
  close-end and open-end mutual funds.
• Presently open-ended mutual funds stand at Rs.
  325 b Feb-2008. The market cap of close end
  mutual funds was Rs. 36.24 b 11-4-08.
• Out of Rs. 325 b open end funds, Rs. 124 b 38
  were in equity funds, and Rs. 127 b 39 were in
  income fund.
• Courtesy Monthly Mutual Fund, A Financial Daily
  publication, Editor Mr. Amir Ashray.

13
Mutual Funds International

• USA In 1998, for the first time in history,
  total assets of mutual funds exceeded the total
  assets of all the nations banks.

• USA There are more mutual funds than listed
  companies.

14
Mutual Funds Recent Happenings

• Non-Banking Finance Companies and Notified
  Entities Regulations 2007
• Close-end mf to be converted into open-end
  scheme Certificate holders to decide in meeting
  to be held within five years Regulation 75.

• Accounting issue Whether the amc should
  consolidate their mf holdings in its financial
  statements.
• Close-end mf now deduct 10 tax at source on
  dividend payments.

15
Investors and Mutual Funds

• Why should I invest in a mutual fund at all?
• Should I invest in an open end or close end mf?
• Should I invest in this one or that one?
• Tell me about the best performing Fund?

• Advantages of mf for an investor
• Daily publication of net asset value
• Time limit for declaring financial results
• Low betas and volumes close-end
• Available at lower of nav close-end
• Professional management
• Ease of redemption

16
Investors and Mutual FundsWhat is your take on
the following

• Mutual funds are still a mystery to many
  investors
• The advent of one mf after the other has
  resulted in increased votality at KSE.

• Disadvantages of mf for an investor
• Multiple charges open-end front load, back
  load.
• Offering-redemption spreads
• Management fee related to assets managed, not
  performance.
• Information gaps. E.g. performance comparison
  with benchmark.

17
Basic Accounting Concepts

• Assets Liabilities Equity
• Book value net asset value asset liability
  equity
• Return on investment is made up of capital gain
  and dividends.
• Capital gain is made up of realised and
  unrealised capital gain.

18
Financial Reporting of Mutual Funds

• External
• Internal

19
External Financial Reporting Framework

• Approved accounting standards
• International Accounting Standards.
• International Financial Reporting Standards.
• Trust Deed
• The Non-Banking Companies Finance Companies
  Establishment and Regulations Rules 2003.
• The Non-Banking Finance Companies and Notified
  Entities Regulations 2007.
• The Asset Management Company Regulations 1995.
• Directives issued by the SECP.
• So what happens in case of a conflict?

• Open-end Funds
• Close-end Funds

20
External Financial Reporting

• Open-end
• Close-end
• The difference between certificates and units

• First Quarter
• Second Quarter Half-yearly.
• Third Quarter Three Quarters
• Annual Report

21
External Financial ReportingClose-end Funds
Contents

• Fund Manager Report
• Report of the Trustee
• Independent auditors report
• Statement of Assets and Liabilities
• Income Statement
• Distribution Statement
• Statement of Movements in Net Asset
• Cash Flow Statement
• Statement of Changes in Equity
• Statement of Accounting Policies
• Notes to the Accounts
• Income Statement of AMC

• Additional Information in Annual Report
• Schemes Information
• Vision Statement
• Mission Statement
• Directors Report
• Results for last six years.
• Statement of Certificates held by directors and
  management.
• Pattern of holdings
• Categories of holdings
• Statement of Ethics and Business Practices.
• Core Values
• Statement of compliance with Code of CG.
• Review report by auditors for compliance with the
  best practices of CG.

22
Model Annual Report of a Close-end MFFunds
Information

• What is there?
• Investment Advisor
• Board of Directors
• Audit Committee
• Trustee
• Bankers
• Auditors
• Legal Advisor
• Registrar
• Rating

• Best Practices Notes

23
Model Annual Report of a Close-end MFFunds
Information

• What is there?
• Investment Advisor
• Board of Directors
• Audit Committee
• Trustee
• Bankers
• Auditors
• Legal Advisor
• Registrar
• Rating

• Best Practices Notes
• BOD. Identify the non-executive directors also
  refer to Statement of Compliance
• BOD. How about stating the date of appointment of
  directors?
• Investment Committee. The core activity of a mf
  is investment. Who is managing the process?
• Rating. There are two type of ratings. Disclose
  which one is stated and what it means?

24
Model Annual Report of a Close-end MFMission
Statement

• What is there?
• Golden ArrowTo set a standard of investing in
  better performing and result oriented securities
  by adopting best business practices and ethics.
• Pakistan Strategic Allocation Fund To deliver
  enhanced returns from the capital market by
  combining investment decisions based on
  fundamental equity research and asset allocation
  based on quantitative disciplines so as to
  benefit from value investing as well as from
  price volatility and market inefficiencies.

• Best Practices Comments
• 1.

25
Model Annual Report of a MFNotice of Meeting

• What is there?
• Not all the close end funds hold agm.
• Two funds that hold the agm are
• AlMeezan Mutual Fund
• Golden Arrow

• Best Practices Comments
• Certificate holders should be provided a forum to
  discuss with the management.
• We know how agms are conducted in this part of
  the world, but with all its limitations, its
  better to have it.

26
Model Annual Report of a Close-end MFMission
Statement

• What is there?
• Golden ArrowTo set a standard of investing in
  better performing and result oriented securities
  by adopting best business practices and ethics.
• Pakistan Strategic Allocation Fund To deliver
  enhanced returns from the capital market by
  combining investment decisions based on
  fundamental equity research and asset allocation
  based on quantitative disciplines so as to
  benefit from value investing as well as from
  price volatility and market inefficiencies.
• UTP A30 Fund Pursuit of professional
  excellence.

• Best Practices Comments
• Al Meezan Mutual Fund To be the leading mutual
  fund in the industry, outperforming the benchmark
  on a consistent basis, and providing shareholders
  with the best combination of current income and
  future growth on a risk adjusted basis.

27
Model Annual Report of a MFReport of the
Directors of the Investment Advisor

• What is there?
• Profile
• Investment strategy
• Fund performance
• Income distribution
• Corporate governance
• Attendance of Board Meetings
• Insider trading
• External auditors
• Outlook
• Commitment
• Acknowledgements

• Best Practices Comments
• 1.

28
Model Annual Report of a MFPerformance Table

• What is there?
• Performance table discloses the performance of a
  fund over say last 10 years.
• AMMF is the only fund to do so.

• Best Practices Comments
• It is important for the users to see performance
  over long term.
• Possible reason for non inclusion Some funds do
  not have a track record of longer duration.

29
Model Annual Report of a MFBenchmark

• What is there?
• Most equity funds use KSE 100 as a benchmark.
• Golden Arrow The KSE 100 started the year at
  9,989 and close it at 13,772 gaining 37.87
  during the period.

• Best Practices Comments
• Use of KSE 100 as a benchmark is not totally
  correct as most funds are not restricted to
  invest in KSE100 only infact KSE All index may
  be more appropriate.
• For balanced fund, most do not specify benchmark
  return at all.
• I wonder why dividend yield of KSE 100 is not
  added to the capital gain.

30
Model Annual Report of a MFPerformance
Evaluation Example 1

• What is there?
• Golden Arrow The KSE 100 started the year at
  9,989 and close it at 13,772 gaining 37.87
  during the periodthe fund returned 44.70 during
  the year...the NAV at Rs. 7.86 rose to Rs.
  10.65including Rs. 0.50 per share dividend.
• Rs. 7.86 0.50 7.36
• Rs. 10.65 7.36 3.29
• Rs. 3.29 / 7.36 44.7

• Best Practices Comments
• Quite rightly, dividend paid out of the income of
  last year but not reflect in the financial
  statements of that period is reduced from opening
  nav.

31
Model Annual Report of a MFPerformance
Evaluation Example 2

• What is there?
• PSAF PSAF delivered a NAV-based total return of
  26.49 compared to 37.87 returns by the KSE 100
  index during 2007.

• Best Practices Comments
• A straight forward statement of fact. However, no
  support of how 26.49 has been computed, is
  provided.
• Opening nav 13.30
• Closing nav 13.60
• Adjusted opening nav 13.30 2.50 10.8
• Eps and unrealised gain on available for sale
  investments 2.8
• Change in nav 2.8 / 10.8 25.93
• The return figure stated is not correct.

32
Model Annual Report of a MFPerformance
Evaluation Example 3

• What is there?
• AMMF AMMF recorded a NAV-based return of 27
  versus market return of 17.16 as measured by Dow
  Jones JS Pakistan Islamic Index.
• 37.87 returns by the KSE 100 index during
  2007.

• Best Practices Comments
• I wonder if the choice of bench mark is
  appropriate.
• Opening nav 16.96
• Closing nav 18.55
• Adjusted opening nav 16.96 3 13.96
• Eps and unrealised gain on available for sale
  investments 4.59
• Change in nav 4.59 / 16.96 27.06
• The return figure stated is correct.

33
Model Annual Report of a MFPerformance
Evaluation Example 4 Open end

• What is there?
• Pakistan Stock Market Fund During the twelve
  months PSM delivered a total return of 29.41
  compared to the KSE 100 index appreciation of
  37.87.
• PSFThe Boardhas already declared distribution
  in the form of bonus units to A class units and
  equivalent cash for B class units at a rate of
  Rs. 25 per unit. The bonus of Rs. 25 per unit is
  29.66 on the opening NAV for FY 2007.

• Best Practices Comments
• The statement is not supported by any
  computation.
• There is no requirement of per certificate
  statement of movement in reserves for open end
  funds. This makes it even more difficult to
  validate claims about returns of open end funds.

34
Close-end MF Why its market value consistently
remains below its nav?

• All the close end mf are available below their
  nav. For example on 13-3-08, First Dawood Mutual
  Fund at Rs. 8.20 nav 14.51, discount 43,
  PICIC Growth Fund at Rs. 31.45 nav 50.57
  discount 40. Why?

• Possible explanations
• The dividend yields of these funds is not
  compatible with the market. All earnings are not
  available for distribution.
• Because they under perform the market.
• They are not popular because of low betas and low
  turnover.

35
Model Annual Report of a MFFund Managers Report

• What is there?
• Fund performance
• Market performance
• Economy
• Fund activity
• Future outlook

• Best Practices Comments
• I think that a lot of information provided in the
  Fund Managers Report is largely unrelated to the
  performance of the Fund.
• It is true that national macro variables affect
  portfolio. However, is it what user is looking
  for.

36
Model Annual Report of a MFReport of the Trustee

• What is there?
• UTP A30 Fund JS ABAMCO Limited the management
  company of UTP A30 Fund has in all material
  respects managed UTP A30 Fund in accordance with
  the provisions of the Trust Deed dated December
  26, 2005 of UTP A30 Fund and Non-Banking Finance
  Companies Establishment and Regulations Rules,
  2003, during the period from July 1, 2006 to June
  30, 2007.

• Best Practices Comments
• 1.

37
Model Annual Report of a MFStatement of
Compliance with Best Practices of Code of
Corporate Governance

• What is there?
• PSAF At present the Board includes six
  non-executive directors however, none of the
  directors on the Board represent minority
  shareholders.

• Best Practices Comments
• There is no representation of minority
  shareholders on Board of any Fund.
• None of the funds identify the non-executive
  directors on its Board. Should it be done? Where?

38
Model Annual Report of a MFReview Report to the
certificate holders on statement of Compliance
with Best Practices of Code of Corporate
Governance

• What is there?
• Standard Wording Based on our review, nothing
  has come to our attention, which causes us to
  believe that the statement of compliance does not
  appropriately reflect the companys compliance,
  in all material respects, with best practices
  contained in the Code of the Corporate Governance
  as applicable to the Company for the year ended
  June 30, 2007.

• Best Practices Comments
• The language needs a change. Double negatives are
  against any basic rule of communication.
• I see this report more as a waste of precious
  space that may be devoted to more meaningful
  information. Or is it that auditors do it to
  justify the additional fees?
• If I were to do it Based on our review, we
  believe that the company has complied with the
  Code of the Corporate Governance in all material
  aspects during the year ended 30 June 2007.

39
Model Annual Report of a MFStatement of Assets
and Liabilities

• What is there?
• Assets
• Liabilities
• Net assets
• Shareholders equity

• Best Practices Comments
• 1. Disclosing nav per certificate at the bottom.
  AMMF did so for 2006 when I suggested in 2005
  agm. However, its again the same in 2007.

40
Model Annual Report of a MFIncome Statement

• What is there?
• Income
• Expenses
• Net income for the year
• Earning per share

• Best Practices Comments
• Income is stated as one liners.
• Gain on sale of investment is shown as a net
  figure. Losses are not disclosed by any mf.
• Dividends. It is not possible to figure out the
  no-dividend scrip as dividend is disclosed as one
  liner.
• Dividends. There is no mention of dividend yield
  at all anywhere in the report whereas it is the
  bed rock of earning of a stable portfolio.

41
Model Annual Report of a MFIncome Statement
Expenses

• What is there?
• Expense per certificate for selected close end
  funds
• Pakistan Premier
• 2007 0.42
• 2006 0.47
• Pakistan Strategic Allocation Fund
• 2007 0.45
• 2006 0.56
• AMMF
• 2007 0.40
• 2006 0.47
• Golden Arrow
• 2007 0.25
• 2006 0.19

• Best Practices Comments
• Management charges amounts upto 80 of the total
  expenses, followed by brokerage upto 20.
• Certificate holders of close end mf pay anywhere
  from 2.5 to 5 as expenses, which appears to be
  on a higher side.
• AKD Index tracker fund is probably the cheapest.
• For open ended funds, computing expense per unit
  is difficult because of purchase and redemption
  of units.

42
Model Annual Report of a MFDistribution Statement

• What is there?
• This statement simply shows movement in the
  unappropriated income account, normally because
  of payment of cash dividend.
• See AMMF, PPF, Golden Arrow, PSAF

• Best Practices Comments
• There is no point of preparing this statement
  when the same information is provided in the
  statement of changes in the equity.
• We must state that some funds do not prepare soce
  e.g PPF and PSAF.

43
Model Annual Report of a MFStatement of Movement
in Equity and Reserves per share certificate

• What is there?
• This statement simply reconciles the opening nav
  per share with the closing.
• Change in nav is normally because of eps and
  distribution.
• EPS for the year is added to the opening nav.
• Distributions made during the year, even those
  relating to the previous year, are deducted from
  it.

• Best Practices Comments
• This is just about the only statement that I see
  in the accounting literature that translates
  absolute figures into something one can relate
  to.
• The data here is used for computing change in
  nav and comparing it with benchmark.

44
Model Annual Report of a MFCashflow Statement

• What is there?
• Cash flows from operating activities
• Cash flows from financing activities
• Net increase / decrease in cash and cash
  equivalents
• Opening cash balance
• Closing cash balance

• Best Practices Comments
• Cash to investment conversion and vice versa is
  the most critical aspect of any fund.
• Its a disappointment to see cash flows from
  operating activities being prepared on indirect
  method which discloses change in investment as a
  one liner.
• Management hold auditors for doing so, whereas
  its them who prepares the f/s. I think not many
  know how to do it.
• F/s of JS Funds provide figures of sale and
  purchase of investments.

45
Model Annual Report of a MFNotes to the
Financial Statement

• What is there?
• Legal status and nature of business
• Basis of presentation
• Statement of compliance
• Summary of significant accounting policies

• Best Practices Comments
• How about preparing a separate statement called
  Statement of Accounting Policies and including
  this stuff there.
• This will allow the preparers to start notes to
  f/s from serial number 1.

46
Model Annual Report of a MFNotes to the
Financial Statement Assets

• What is there?
• Bank balances
• Investment in marketable securities available
  for sale.
• Investment in marketable securities held for
  trading.
• Derivative financial instruments
• Deposits and receivables

• Best Practices Comments
• The core activity of a mf is investments. In
  simple terms, its about cash-to-investments and
  investment-to-cash.
• We will discuss outline of investments here and
  take it up later in detail.

47
Model Annual Report of a MFNotes to the
Financial Statement Liabilities

• What is there?
• Payable to investment advisor
• Payable to Trustee custodian
• Payable to SECP
• Accrued expenses and other liabilities

• Best Practices Comments
• No computation is provided about how the amount
  has been arrived at for payments to investment
  advisor, trustee or SECP.
• Possible reason the amount of computation is an
  average of six months. Good one?

48
Model Annual Report of a MFNotes to the
Financial Statement Expenses

• What is there?
• The only expense having the privilage of a five
  line disclosure is..auditors remuneration.
• In most cases it varies between 1-1.5 of
  expenses, not income.

• Best Practices Comments
• I like mf also because of mandatory change of
  auditors after five years. This policy is a model
  that should be emulated in all the sectors.
• Other services should be restricted.
• Joint auditors should be appointed.

49
Model Annual Report of a MFAppointment of
Auditors

• What is there?
• It is good to see that audit committees are in
  place.
• Mandatory rotation of auditors is another
  positive point.

• Best Practices Comments
• 1. How about a charter and report of audit
  committee and a record of its attendance to be
  included in the annual report.

50
Model Annual Report of a MFEarning per share
certificate

• What is there?
• This is computed as per IAS devoted on earnings
  per share.

• Best Practices Comments
• 1. Eps accounts for the change in nav per share
  certificate.

51
Model Annual Report of a MFRelated party
disclosures

• What is there?
• Investment advisor is a related party interested
  in its remuneration and dividend payment.
• If mutual fund is connected to a bank through
  investment advisor that too becomes a related
  party.
• Shares held by the directors and officers are
  also stated here.

• Best Practices Comments
• 1. The disclosures here are also in accordance
  with the relevant ias on related party.

52
Model Annual Report of a MFMarket Rate of Return
Sensitivity Position

• What is there?
• MROR risk is the risk that the value of a
  financial instrument will fluctuate due to
  changes in the market interest rates.
• This is relevant for the income funds. On the
  other hand, equity investments are not exposed to
  this risk.

• Best Practices Comments
• 1.

53
Model Annual Report of a MFRisk Management

• What is there?
• Market risk
• Credit risk and concentration of credit risk
• Liquidity risk

• Best Practices Comments
• 1. The financial reporting of mf is primarily on
  fair value basis rather than historical cost
  basis.

54
Model Annual Report of a MFFair Value of
Financial Instruments

• What is there?
• The accounting of mutual fund is now based on
  reporting of fair values rather than historical
  cost.

• Best Practices Comments
• 1.

55
Model Annual Report of a MFPerformance Table

• What is there?
• Net assets
• Net income
• NAV per share
• Eps
• Dividend distribution

• Best Practices Comments
• 1. The performance table provides information.
  However, it does not compares the performance
  with the benchmark.

56
Model Annual Report of a MFNon-adjusting Events

• What is there?
• Dividends for the year announced after the
  reporting date are considered as non-adjusting
  events.
• That is, no reflection is made in the financial
  statements for the dividends announced after the
  reporting date.

• Best Practices Comments
• Dividends result in a change in nav in the period
  in which they are paid.
• Payment of dividend to unitholders reduces
  period nav, and prevents straight comparison with
  the benchmark.

57
Model Annual Report of a MFPattern of
Shareholding

• What is there?
• Categories of shareholders. Golden Arrow.
  Individuals 49.47, Investment companies 12.15,
  Joint Stock Companies 33.12.
• UTP Income Fund. This information is not required
  for open ended fund.

• Best Practices Comments
• 1.

58
Model Annual Report of a MFPattern of
Shareholding

• What is there?
• Categories of shareholders. Golden Arrow.
  Individuals 49.47, Investment companies 12.15,
  Joint Stock Companies 33.12, Financial
  institutions 1.8.
• PPFL. Individuals 55.2, Joint stock 22.3,
  Financial institutions 18.9.
• UTP Income Fund. This information is not required
  for open ended fund.

• Best Practices Comments
• Information for the open end funds should be
  there.
• Comparision of Golden Arrow and PPFL. PPFL
  appears to be more popular with individuals and
  financial institutions.

59
Model Annual Report of a MFStatement of Income
and Expenditure of Investment Company

• What is there?
• Income
• Remuneration
• Dividend income
• Operating expenses
• It comes with the statement that other revenues
  and expenses not relating to Investment company
  has not been included in the above statement.

• Best Practices Comments
• This statement is not required for the open end
  funds.
• I am not sure about the purpose of this
  statement.
• It hardly conveys any meaningful information.
• Expenses directly incurred by the investment
  company should be stated separately from
  allocated ones.

60
Model Annual Report of a MFPension Fund

• What is there?
• Pakistan Islamic Pension Fund. Statement of
  Assets and Liabilities. Assets and Liabilities
  are segregated in three sub-funds Equity, Debt,
  Money Market.
• Total income and total expenses have also been
  similarly distinguished.
• Eps for each sub-fund has been calculated.
• Cash flow statement also does the same. Prepared
  on indirect method.

• Best Practices Comments
• 1. AMMF Independent Assurance Providers Report
  on Shariah Compliance to the Shareholders.
  Report by independent auditor asked to verify
  compliance with Shariah guidelines prescribed by
  Shariah Advisor for the year ended 30-6-07.

61
Internal Financial Reporting Package

• I have seen reporting packages of a couple of
  asset management companies.
• They are so well presented but the relevant
  information quotient appears to be on a low side.

• One possible reason is because they are required
  to anticipate the user needs.

62
Critical Issues in Financial Reporting

• Technology and real-time accounting.
• Interaction with trustee and custodian.
• Compliance regime.
• Human resources.
• Cashflows and operational coordination.

• I am grateful to the following for their time and
  inputs in this section
• Mohammed Mohsin, Arif Habib Investments
• Sulaiman Lalani, CFO, JS Investments
• Amin Hussain, CFO, AKD Investments
• Owais Wasti, CFO, Almeezan Investments.

63
Critical Issues in Financial Reporting
Technology and real-time accounting

• Technology will continue to influence the way
  fund accounting is carried out.
• Days of excel sheet are gone.
• With so many funds under management, enterprise
  resource centre should be capable of processing
  information collected from multiple entities.

• MF is just about the only sector that publishes
  its nav on daily basis.
• In its true sense, MF is the best example of real
  time accounting.
• Asset management companies have invested millions
  in such systems.

64
Critical Issues in Financial Reporting
Interaction with trustee and custodian

• A separate institution of trustee custodian is
  there to look after the assets held by the mf.
• The daily interaction requires accurate and
  prompt responses and reconciliation as a
  procedure in case of change.

• Reconciliation of investment quantity with one
  reported by the trustee is a daily process.

65
Critical Issues in Financial Reporting
Compliance regime

• Most CFOs believe that they will be over whelmed
  with more and more regulations in all the
  aspects, mainly accounting and operations.
• It requires a lot of time to absorb ongoing
  development.
• Cost of regulations will increase in line with
  the inflationary pressures.

• Constant review of regulations by regulators
  based on interaction with the stakeholders often
  hits snags at first opportunity.
• AMC will be extremely constrained to offer low
  cost alternatives to the investors.

66
Critical Issues in Financial Reporting Human
resources

• Employee turnover is a major head ache for all
  asset management companies.
• There is a shortage of experienced staff.
• Expectations of staff tends to be on a higher
  side for employer to retain them.

• Retaining competent employees is a challenge for
  any business but is critical for financial
  services.
• Employees leave at the first opportunity and no
  amount of bonuses appear to restrain them.
• High employee turnover plays a havoc with
  internal control procedures.

67
Critical Issues in Financial Reporting Cashflows
and Operational Coordination

• Cashflows are critical for open end mutual fund.
  Close end funds have a fixed pool of assets
  available at all times.
• Coordination with operations is critical for them
  to implement investment decisions.

• This is what makes cashflow statement prepared on
  indirect method to be so incompatible with user
  needs.

68

• End of Day 1
• Thank you

69
Mutual FundsFinancial Reportingand Internal
ControlsDay 2

• Presented by
• Altaf Noor Ali
• Chartered Accountant

70
Day 2 9.30 am 5.00 pmMutual Funds
Operational Internal Controls

• Mutual Fund Investment policy.
• MF Investment Committee decision-making and
  Operational internal controls.
• MF Management and Employee frauds.
• Role of management oversight, internal audit and
  HR.
• MF Key performance indicators for Board.

• Session Objectives
• Outline decision making in mf for investment
  activity.
• Outline critical internal control procedures.

71
Mutual Funds Investment Policy

• Investment policy is required to be disclosed in
  the offering document see next slide.
• MF do not disclose this policy in annual report
  but state Investment Objective and Strategy.
• In case of UTP Income Fund, or funds of similar
  nature, note that investment grade or rating of
  instrument is not disclosed.
• We also see that in case of equities the rating
  are not mentioned. Wonder if that would make any
  difference.

• UTP Income Fund. Investment Objective and
  Strategy.UTP-Income Fund aims to preserve
  investors capital while providing a regular
  stream of current income which is higher than
  that offered by commercial banks on deposits of a
  similar liquidity profile. The fund operates a
  diverse portfolio of investment grade debt
  securities, government securities, and money
  market instruments. The fund maintains liquidity
  in the form of CFS investments, spread
  transactions and bank deposits.

72
Mutual Funds Investment Policy 1

• Investment policy is generally framed to include
  as many options as possible.
• It defines where you can invest and where you
  cannot.
• Extract PSAF. The investments may include traded
  securities or contracts covering debts, equity,
  money market transactions such as COT contracts
  and inter-bank placements, etc. and deposits in
  the Pakistani Rupee.

• Stock Market Investments. The primary criteria
  for investment in equity securities shall be high
  quality shares of listed companies that offer
  good value in terms of potential dividend yield
  or growth in the stock price.
• Fixed Income Investments. The Fund may invest in
  the short-term in a mix of spread transactions,
  Carry Over Transactions COT, investment grade
  debt securities money paper instruments
  commercial paper inter-bank market and short
  maturity reverse repo transactions.

73
Mutual Funds Investment Policy 2

• Investment policy is also includes what a fund
  cannot do.
• These are called Investment Restrictions.
• Text here from Offering Document of PSAF 21 Aug
  2004.

• PSAF will not at any time extract
• Effect a short sale in any security
• Purchase any security in the forward contract
• Purchase any security on margin
• Participate in a joint account with others in any
  transaction
• Apply any part of its assets to real estate,
  commodities or commodity contracts.
• Invest more than 25 of the net asset value of
  the fund of any one business sector.

74
MF Investment Policy and Reality

• Investment policy is what the objective clause of
  memorandum of articles is to a company.
• The objective clause of a memorandum is
  deliberately kept large enough to permit a
  company to engage in any foreseeable activity.
• I consider investment policy to be specific. For
  example, if we are investing in equity,
  investment policy would say that we should not
  invest in a company with less than five year
  record of dividend.

• The reality is that PSAF is an equity fund.
• What if its investment committee was to come up
  with rules like
• We invest in companies with more than one million
  shares in free float.
• We invest in companies with trailing p/e of not
  more than 15.
• We invest in companies with dividend yield of
  above 5.
• We do not invest in textiles, etc.
• Similar rules can be framed for any type of
  investment.

75
MF In-house research and conflict of interest

• In-house research is subject to pressures and
  bias.
• The most famous of their output - the fair
  value assigned periodically is a subject of many
  jokesand abuses.

• Resolving this conflict of interest has been a
  subject of major controversy in US.
• Recently some measures have been taken by secp to
  tackle this aspect.
• My personal experience is that in house research
  is sketchy and consensus oriented.

76
MF Financial Reporting of Investments

• The management classifies the investments as
  held for trading through profit and loss
  account or as available for sale.

• Addressing User Needs
• A basic need of the user is to know the reasons
  for portfolio turnover. There is hardly any
  explanation for it when the general trend of the
  market is upwards.
• MF incur millions as Brokers commission.
• Unfortunately, even after so managing the
  portfolio so actively, most mf tend to under
  perform popular indexes.

77
MF Investment Commitee

• The investment decisions of a fund are taken by
  an investment committee.
• Regulation 45 requires an investment committee
  comprising of atleast 3 members. Its decision
  should be documented.

• Is it not strange that there is no mention of
  investment committee in any fund?
• The users do not know who is taking decisions
  with their funds. They do know its not the CEO
  who would be doing everything.

78
MF Operational Internal Controls

• The core activity of a mutual fund is investment.
  With each asset management company managing so
  many funds, chances of conflict of interest are
  very much there.
• The operational internal controls exercised by
  the Board, transcending to Fund Manager and
  levels below is a key issue.

• Best Practice AMMFOn Dec 31, 2005 Almeezan
  Investment Management Limited implemented Asset
  Manager Code of Professional Conduct and its
  policies and procedures. Annual Report 2006
• I do not know what it means as no further details
  were provided.

79
MF Operational Internal Controls 2

• How appropriate it is for an asset management
  company to manage funds of similar nature?

• Avoiding and resolving conflict of interest
  situation is a major task for the management of
  the asset management companies.
• It is clear to see that mf have enormous power at
  their disposal.
• Without proper accountability it is likely to be
  misused.

80
MF Operational Controls - Core

• The core activity of a mutual fund is investment.
  With each asset management company managing so
  many funds, chances of conflict of interest are
  very much there.

• Clearly written approved policies and procedures
  for foreseen recurring situation and its
  application.
• Internal code of conduct for the Fund Managers
  and operatives.
• Clean and valid human resources.

81
MF Operational Controls - Principals

• The Board is responsible for instituting proper
  internal control.
• Providing proper accounting system and personnel.
  
• Reinforcing internal control environment with
  compliance and internal audit.

• Examples of internal control
• Recording of investment committee meeting.
• Cameras in dealing room.
• Recording telephone calls.
• Restriction on use of personal mobiles during
  official hours.
• Restriction on use of personal transactions.
• Restrictions on speaking to anyone about the
  transactions.
• Inducting employees after proper confirmations.

82
MF Control Procedures

• Regular reconciliations are an important aspect
  of controlling investment activity.
• Reconciliation should be prepared regularly.
• All entries are made promptly to let operatives
  have adequate and accurate position information
  before commitTing the entity to a legally binding
  position.

• Types of reconciliations
• Reconciliation of entitys records to records
  maintained by custodian.
• Reconciliation of all clearing and bank accounts
  and broker statements to ensure all outstanding
  items are promptly identified and cleared.
• Reconciliation of operational record with minutes
  etc.

83
MF Management and Employee Fraud

• Day to day dealing of equities increases the
  threat of fraud.
• Income funds are relatively safe.

• The greatest level of threat is that of
  management fraud.
• The perception in the market is that mf are
  handled by few individuals who make the market
  dance to their tunes.
• The unusual volatility witnessed in the market is
  cited as evidence.

84
MF Management and Employee Fraud 2

• The nature of management frauds in mf is
  completely different than in other entities.
• Chances are that the nature of fraud will be in
  the form of insider trading or market abuse which
  is most difficult to detect and prosecute.

• It is quite well reported in press that mf
  indulge in portfolio window dressing towards the
  year-end.
• The nature of management fraud may be stated as
  it wont make you poor but it will make me
  rich.
• There is hardly any safeguard. If you restrict
  personal trading, it can be done by using someone
  else as sidekick.

85
MF Management and Employee Fraud 3

• What nature of frauds in mf have occurred in
  Pakistan?

• Its unusual but I have not come across any fraud
  in mf. The closest thing to my knowledge is a
  financial entity that bought a card and was
  involved in reckless trading of stock, leaving
  its stakeholder with losses of quarter billion
  and many panadols for secp. Still in progress.

86
Role of Management Oversight

• Management should establish suitable guidelines
  to ensure that investment activity that takes
  place is within that framework.
• Identify risks and implement suitable systems to
  manage and control those risks.

• Segregation of duties and the assignment of
  personnel. Divided into committing the entity,
  settlement, and its recording in the books.
• Sophisticated computer system are capable of
  keeping track of investment activities.
• Also, to generate exception reports for breach of
  internal regulations.

87
Role of Internal Audit

• The knowledge and skills required to understand
  and audit investment activities is quite
  different from those needed in auditing other
  entities.
• The work of internal audit may assist external
  auditor in assessing the control risk.

• Reviewing the appropriateness of policies and
  procedures and managements compliance with them.
• Reviewing the effectiveness of control procedure.
• Reviewing the process of committing entity
  resources for investing and vice versa.
• Provide management with the assurance that
  investment activities are being properly
  controlled.

88
Role of Human Resources

• The quality of human resources at the amc is
  directly related to the quality of its HR
  function.
• By HR function we mean not only how HR is aligned
  to achieve the objective but also to the
  management policies it applies.

• Areas requiring special attention
• Use of web-site for talent search.
• Induction and confirmation procedure
• Organisation structure
• Compensation policy
• Performance evaluation
• Training
• Exit policy

89
Key Performance IndicatorsFinancial and
Non-financial

• Framing detailed investment rules and applying
  them in portfolio construction.
• Selection of proper benchmark.
• Comparative study with other funds.
• Portfolio evaluation on the basis of metrics like
  price/nav, price/earnings, price/dividend,
  average price per share.

• Actively participating in the agm of companies
  invested.
• Constantly monitoring control environment.
• Resolving conflict of interest situation relating
  to in-house research.
• Acquiring right kind of technology to process
  financial reporting.
• Employee turnover.
• Quality of internal audit reports

90
MF Financial Reporting and Internal Controls

• We request your feedback about this program.

91
MF Financial Reporting and Internal Controls

• Certificate Distribution Ceremony

92

• End of Session
• Thank you for being with us
• Thank you to Mr. Nasim Beg, Chairman, MUFAP
• Thanks to my team at ICIL
• Farhan, Sattar, Shazia, Sania
• Thanks to team here at Sheraton
• Farooq, Lala and team
• Thanks to my family for being patient
• Ayesha, Aneesha, and Asr