Why should one invest in mutual funds?

Wealthy people have their wealth in form which offers them returns. The forms in which wealthy people park their money is real estate, bonds, debentures, mutual fund units, shares and stock along with others.

Take the example of shares which are in fact part ownership of corporations. If you invest in shares of a corporation you in fact own part of it thus taking part in its future profits and losses.

If you invest shares of Cement Company, you expose yourself to risks affecting the cement industry negatively. Moreover, there are some factors that can affect your company specifically like bad management, technological obsolescence and others.

In order to reduce company specific risk exposure, you need to invest in a number of companies. Likewise, if you want to reduce risk exposure to a certain industry you need to invest in different industries.

The more variety of shares you purchase the less risk exposure you will have. Reducing your exposure to risk by way of investing in multiple securities is called diversification.

Diversification when rightly implemented can reduce your risk exposure. But there are costs associated with buying number of different securities e.g. cost of ordering, accounting, etc. In order to get full benefit of diversification you need to invest a large amount in different securities. An individual has limited amount of capital and cannot diversify, which keeps him away from investing.

The problem of small capital can only be overcome by pooling of funds by different interested individuals. But how to pool funds and also the issue who would manage the funds on behalf of investors arises.

The answer to all these questions can be overcome by utilizing a vehicle called mutual fund.

Mutual funds are pool of funds managed by fund manager for the benefit of isolated investors, who don’t have expertise in the investment field.

When you invest through mutual funds, you benefit from the expert management. The analysts working for the mutual fund industry generates financial models which grows your capital as well as provides protection to your capital.

With Mutual fund investing you also get benefit from diversification, and economies of scale.

The one thing anyone interested in investing through mutual funds should keep in mind that the return from mutual fund is dependent not only on the financial markets performance but also the overall economic performance.

So start investing with good mutual fund manager and select the mutual fund after due diligence.

Disclosure: any thing/ content isn’t substitute of professional advice and the blogging team isn’t responsible for any loss/ damage resulting from acting on information from this blog.

Growth of Islamic Finance in Pakistan

Assets of Islamic banks have doubled in the last four years and SECP is now considering amending laws and giving tax relief to enable them to issue sukkuk bonds and real estate investment trust.

“The assets in Islamic banking (in Pakistan) have doubled, jumping from Rs837 billion to Rs1.6 trillion, from 2012 to 2016, now accounting for 11.7% of the total banking assets,” said Securities and Exchange Commission of Pakistan (SECP) in a handout on Saturday.

Read more about Islamic Finance

Non-banking financial institutions (NBFI) enjoy more support in religious classes of the country than Islamic banks. This is evidenced by stronger growth of assets in Sharia-compliant NBFI. The market share of assets in Islamic NBFI has grown from 14%, in 2002, to 33% now.

 “The SECP has recently conducted two consultation sessions with market participants to facilitate issuance of sukuk and real estate investment trust (REIT),” said Usman Hayat, head of the Islamic Finance Department at the SECP.

“The SECP is analyzing industry proposals and it shall consider making appropriate amendments to the relevant regulations, further reducing the cost and hassle for both issuers and investors. The industry proposals pertaining to tax issues regarding sukuk and REIT are being referred to the FBR,” he added.

At present 21 banking organizations are offering Islamic banking services in the country through 2,322 branches in 112 districts across the country.  “The SBP has a holistic approach to the promotion of Islamic banking and is providing enabling policy environment, Sharia governance, risk management, and capacity building,” says Ghulam Muhammad Abbasi, head of the Islamic Banking Department at SBP.

The assets of Islamic financial institutions are growing at a rapid pace but it is yet to be seen as how Islamic is the Islamic finance.

Using customers' money for your startup

Beijing has the world’s costliest rental housing, according to a survey of 15 global cities, with average prices more than 1.2 times average salaries, says a report by the Global Cities Business Alliance, a UK-based not-for-profit organization. The rise in rent, in developing countries like China, India, and Pakistan, has provided developers an opportunity to make money out of thin air.

What they do is to purchase a piece of land and then announce construction of residential plaza or shopping mall over it. Advance booking is announced for residential and commercial units. The advance money collected is then used for completing the project. Unheard in many developed countries, realty development is one of the most lucrative areas for investors.

The use of customers’ money for growth isn’t limited to realty sector only; entrepreneurs can use this method to grow their startups in other areas as well. Take the example of TutorVista, which successfully leveraged this customers’ money model of financing. It started when Krishnan Ganesh hired three teachers and provided them with VoIP internet connection, PC displaying a digital whiteboard along with webcam. It quickly became a 100$ per month tuition service.

Dell is another example of customer funded business. Michael Dell, founder of Dell, started by selling customized PCs to small businesses. The core percept in his business was to collect cash before having to lay out money on chips and computers to be sold. 

Customer funding provides many benefits to the startups. Usually, startups receive higher valuations if they performed successfully for an extended period of time, without external funding. Additionally, strong cash inflows, from customers, allow entrepreneurs to focus on proving business model rather than wooing investors.

In this model of business funding, balance sheet shows more current liabilities than current assets. In accounting term it is called negative working capital. Ironically positive working capital is assumed to be good as it poses less insolvency risk to the business.

Not every startup can be run using customers’ funding. Capital intensive projects need to rely on traditional way of financing. 

Islamic mode of financing

Islamic finance is sharia compliant way of financing.  Sharia, on one hand, prohibits any transaction involving undue uncertainty and on the other hand, it requires avoidance of receiving interest. Sharia defines interest as any income derived in excess of loan. Loans involve personal guarantee of debtor and therefore any such benefit would amount to injustice to debtor. In other words, you can only make profit when you don’t enjoy guaranteed return of the principal amount.

Islamic finance is Sharia compliant way of raising funds

Another important aspect of sharia financing is use of money for ethically healthy projects e.g. you cannot invest in projects involving alcohol manufacturing.  

Sharia compliant financial institutions have developed many sharia compliant products including modaraba, musharika, sukkuk, murabaha etc. Let’s discuss them one by one

Modaraba

Modaraba is financing mode in which one person provides financial resources and other labour and skills to carry out business. Both share profit, in pre-determined ratio, while losses would accrue to one who invested financial resources.

Musharaka

Musharka is mode of financing in which both partners contribute capital and divide profits/losses according to pre-agreed ratio.

Sukkuk

Sukkuk is a bond which gives right of ownership, of some tangible asset, to its holders. The holder of instrument then collects profit as rent of the asset.  Three elements of sukkuk as outlined by Taqi Usmani are

·         Sukuk must represent ownership shares in assets or commercial or industrial enterprises that bring profits or revenues

·         Payments to Sukuk-holders should be the share of profits (after costs) of the assets or enterprise

·         The value payable to the Sukuk-holder on maturity should be the current market value of the assets or enterprise and not the principal originally invested,

Murabaha

Murabaha is sharia compliant form of leasing. In this form no amount is charged for late payment as it would constitute interest (Riba). Murabaha has become the most prevalent form of Islamic financing.