History of Mutual funds:
A mutual fund acts as an investment medium made from a pool of moneys composed from many investors for the intention of investing in securities such as stocks, bonds, money market instruments etc. The concept of mutual funds was first generated in Europe in the nineteenth century beginning from Netherlands. The concept kept on revolving due to the economic changes occurring in the world, until it reached the USA where the concepts were stabilized and used in the year 1924. The perception of mutual fund usage was expanded after War World 2. It was first used in Saudi Arabia in December 1979, by the National Bank (Al-Ahli), under the name “Al-Ahli Short Term Dollar Fund”. But, there were no any official governing rules for such funds until 14 years later in 1993. This trial was quiet thriving for the Kingdom, thus they continued issuing many types of mutual funds through Saudi banks.
Mutual Funds:
Mutual fund is the process of getting a group of people and investing their money on their behalf. It is an idyllic investment method for people who lack financial investment knowledge. When purchasing a mutual fund, you own a share of that fund representing a portion of the holding. Usually, investors invest their money in different types of fund to spread risk and create a portfolio rather than accentuating all their money into one business. In return for these investments; investors gain earnings through dividends on stocks and interest on bonds. There are several advantages for funds holders, some are:
· Professional management: funds are managed through a professional investment manager who has a skillful trading knowledge. This saves investors’ time.
· Diversification: it allows the spread of risk among different holdings; therefore, a loss in any investment is reduced by increase in others.
· Economies of scale: in mutual funds, large amounts of securities are bought and sold, thus the transaction costs are less than what would be paid for an individual’s securities.
· Simple: it has a straight forward process and no complications of payments or procedures.
· Transparency: they are controlled through industry regulations to ensure that investors are treated fairly.
Types of Mutual Funds:
Mutual Funds are divided into two main categories open end fund and closed end fund. An open-end fund is a flexible type of fund per the capital invested, where any increase or decrease depending on the exported units. This represents the percentage of how much the investor had contributed in the fund. The investor can refund how much he invested whenever he wants to. It is a very common type in the financial Saudi Market. While, in a closed end Funds the investors capital is fixed and the unit’s number is unchangeable. To realize the outcome of this fund, an investor should sell the units to another investor or wait until the fund’s expiry period.
Classification of Mutual Funds:
Mutual funds can be classified in various ways. The classification usually depends on the return of the investment, the risk associated with it and the age of the investment. An investor who is investing in mutual funds could either be looking to maintain his capital from rising inflation and economic fluctuations, or to achieve additional income, or grow as an investor or all of those things. Mutual funds include Money Market Funds, Debt instrument Funds, Equity Funds and Balanced Funds.
A money market fund is an investment whose sole goal is for shareholders to earn interest whilst maintaining a net asset value of $1 per share. This type of fund is usually invested in the money market and it usually have high liquidity, low risk and a short life span of less than one year. The securities under this fund represent high quality, liquid debt and monetary instruments. The sole purpose is to provide a friendly, safe investment that can be equivalent to cash and that can be easily accessed. It is usually a low risk, low return investment. Aside from the low risk and highly liquid, money market funds are attractive because they are fee free. It can also give investors an advantage of tax gains if they invested in municipal securities. The types can be either U.S. treasury securities, such as T-bills, CDs, and CPs. A disadvantage however, this type of fund is not insured by the fed.
Moreover, a debt instrument is an obligation that allows the issuing party to raise funds by taking debt and insuring to repay the lender as per the contract. This type of instrument includes notes, bonds, debentures, mortgages and leases. This type of instrument usually allows participants to transfer the ownership of debt obligations from and to parties. Furthermore, it is a legally enforceable evidence of a financial debt as per the agreement of the time of the repayment, plus interest. This type of instrument is extremely important because first, it forces the in-debt party to repay; and second it allows the obligation of any debt to be transferred, making it highly liquid. Without this type of instrument allowing the facilitation of trading, debt would just be a contract between two parties that cannot be transferred. Debt instruments can either be long-term or short term obligations. Short-term obligations are usually to be paid within a year. On the other hand, long-term obligations are due in one year or more and to be repaid through periodic repayments. The risk here varies according to interest rate, credit rating of the company, etc.
Furthermore, an Equity fund, also known as stock fund, is a type of mutual that is invested primarily in stocks. This type of fund is categorized with accordance to the company size, investment style in the portfolio. The size of this fund is usually determined by the market capitalization and the investment style in the portfolio. It can be either domestic or international. Equity funds are ideal for investors who do not obtain enough experience in financial investing, or who do not have a big amount of capital with which to invest. The good thing about equity funds is that the risk of it can be minimized with portfolio diversification. This type of fund is usually managed by experienced professional portfolio manager. Investment and risk can also be varied according to the kind of company it is, and expected growth of the company. The investments can also be categorized according to nationality, global width, or even industrial specificity.
Finally, a balanced fund, also known as hybrid fund, is an option for intermediate-term investors. It usually combines a stock component, a bond component and sometimes, a money market component in one portfolio. Generally, this fund sticks to a fixed mix of stocks and bonds that are steady and reflect either a mediocre or higher equity, component or conservative, or higher fixed income. It is usually at 60% in stocks and 40% in bonds. Balanced funds are for investors who prefer a safe investing environment with modest capital appreciation. Investors with this type of funds usually have dual investment objectives. Mostly, investors who are not risk tolerant utilize these funds to outpace inflation and supplement small needs. Moreover, the bond component of balanced funds serves as a mean to creating an income stream and portfolio diversification and volatility. While bonds hold less volatility than stocks, bondholders have a righteous claim to the assets of a company while stock holders are considered owners; inheriting all the risk in case of bankruptcy.
Market Trends and Developments in Saudi Arabia:
A comprehensive insight on the current mutual fund market shows that the managed total assets by fund managers in Saudi Arabia is divided into 19$ Billion invested domestically and 4$ invested in foreign investments, which sum up to 23$ Billion total assets under management (Research and Markets, 2016).
Saudi Arabia considered one of the first countries that engaged in the concept of mutual funds when the National Commercial bank familiarized them with in 1979 through its open-ended short term dollar funds. The project targeted smaller investors and experienced a fast success due to the low entry barriers, lower service charges, and noticeable improvement to the extent that it grabbed the public attention as time passes (Aleqtisadiah, 2017).
In 1985, the Saudi investors lost believe in almost all the financial markets starting from the stock market as they thought it was conflicting with the Islamic rules; few years later, the Fiqh Academy announced number of conditions supporting that they are permissible, which has a high impact on increasing the investments in the Capital Market in Saudi Arabia. In the mid-90s, the market was growing at 15% and was expected to be the leading growth rate of the financial sector. Then, Saudi Arabia had budget surplus in 2004-2005, which increased the investment growth in the market with the help of the massive amount of liquidity (Sivakumar, Shahid, 2016).
Shariah-Compliant Mutual Funds:
The notion of Islamic Mutual Funds originates in “Musharaka” (Arabic term that stands for sharing), which is an Islamic financing mechanism where all involved parties share any incurred profits/losses.
The marketplace of Islamic finance is acquiring broader popularity in global arena exclusively in the Islamic world due to shariah-compliance amenities. Islamic financing was initiated to entice investors in the gulf and middle east region. However, it rapidly spanned in several other realms of the world likewise. The features that make Islamic mutual funds dissimilar from conventional mutual funds is the omnipresence of a Sharia’ah board (which is a committee responsible for verifying certain fiscal instruments based on Sharia’ah laws) for promulgating fatwa (a verdict on an idea of Islamic law consigned by a mufti/certified authority) interrelated to tolerability of fund structure and investment. Sharia’ah-compliant investments must comply to the main ideologies of auditing/book-keeping of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI).
Sharia’ah-compliant mutual funds operate in a very cognate means as a conventional mutual fund does. However, the key difference is that the Sharia’ah-compliant mutual funds utilizes funds only in Shariah-compliant investments. Shariah-compliant investments are investments which trail the ideologies of Sharia’ah in Islam (which are the teachings of the Quran and Prophet Muhammad’s (PBUH) values/heritage). Therefore, this means that Sharia’ah-compliant mutual funds are free of riba (interest/usury) as well as gharar (speculation/uncertainty). Muslims constitute to roughly 24% of the world’s total populace, hence, some of the most pronounced Islamic establishments began to augment the scope of the financial instruments currently traded in the financial market, to serve the more intricate monetary needs of the high net worth persons residing in the Gulf region. The Islamic interceders began to actualize aggregate investment plans, through special purpose vehicles to administrate the clients’ funds, in accordance with the Sharia’ah laws. Hence, Islamic assets administration tools were conceived as a response to address this need.
Differences Between Shariah-Compliant and Conventional Mutual Funds;
One of the foremost contrasts amid Islamic mutual funds and conventional mutual funds lies the terms of their contracts. The Islamic mutual operate on a profit and loss sharing (PLS) arrangement amongst the two parties. As per the Sharia’ah laws, interest is strongly prohibited. Islamic mutual funds permit financiers to invest in a diversified portfolio, administered by the Sharia’ah board. Contrarily, conventional mutual funds depend on a pecuniary-based convention, where the investors invest in diversified portfolios that generate the highest possible returns/yields. Moreover, per the Sharia’ah laws, investing in any business/activity must be Sharia’ah compliant (for example, investing in alcohol, gambling, cigarettes, etc. are not permissible in Islamic mutual funds. Though, these limitations do not apply to conventional mutual funds (investors can invest in any business/activity that generates profits). Another major difference is that Islamic mutual funds’ returns are grounded on a preordained capital ratio, while conventional mutual funds’ returns are created on an agreed interest rate beforehand.
Performance Comparison:
Mutual funds are within the realm of smaller investment instruments, limited asset selection and are bound to restriction, unlike traditional funds, and thus, are expected to never overpower conventional funds. This could be due to the fact that they have been around of about a decade, hence the expectation of underperformance. Sharia compliancy means that these funds could potentially avoid the effects of certain economic fluctuations like a recession or a stagflation. The independency of these funds results in the insulation of any external financial crisis. Studies have showed the IMFs distribute efficient returns just as well as conventional ones.
However, due to the non-compliance filtering, IMFs have become trickier to predict or understand; as few IMFs outperform CMFs while others fail to do so. In markets like Malaysia and Saudi Arabia, the top markets for Islamic investments, IMFs outperform CMFs. This means that in case the security prices declined, IMFs thrive and increase. This is due to the fact of exclusion of non-sharia-compliant investments; leaving the investor-attractive investments are highly likely to generate a steady stream of return. That being said, it could also be in the fading trust in CMFs in times of crises as a total financial collapse is usually considered. Because IMFs are not related to the traditional financial system, it is wise to consider investing in Saudi Arabia to save oneself from any economic negative fluctuations. Although, in the US markets, IMFs perform better in Bullish markets, where securities are in ever increasing demand. (Merdad, Hassan, 2010).
Nevertheless, IMF managers do not reflect any better market timing ability. Market timing is a strategy of an act to move in our out of the market, or switching between asset classes, by attempting to predict the future market price movements. Furthermore, IMFs also allow for superior stock selection. That coupled with the fact that CMFs usually have negative market timings, a great hedging opportunity is presented for IMFs managers during any economic stress. (Ashraf, 2012).
The following research paper explained what are mutual funds and what is their core advantages over the different kinds of investments. Then, the kinds of funds were explained and discussed. Then the report moved on to naming the different type of mutual funds example Money Market Funds, Debt instrument Funds, Equity Funds. The report moved onto giving a brief description of the history and the development of the funds in the Kingdom from the time they first started in the 80s and quickly becoming the phenomena it is now. However, to be able to adapt to the Saudi Market they had to go through some changes mainly the funds had to be compliant to the Islamic regulations that govern the kingdom. Once this was done it was popularized by the people and had a steady growth of 15% since its beginning. The report moved on to discuss the differences between Islamic and conventional, mainly their natures. The last thing the report focused on was the performance comparison between the conventional and Islamic funds and is which markets each would succeed.
In conclusion, mutual funds are a great medium for anyone wanting to invest in these sort of markets, however depending on the region of the person’s investment it is advisable to first research the performance of both types, IMF and CMF since they both succeed in their own different markets, however when pitted together it will be hard to judge since IMF rarely get affected by the changes in the market.
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