Mutual Funds: Financial Reporting and Internal Controls Day 1

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Mutual Funds: Financial Reporting and Internal Controls Day 1

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Title: 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