Title: Mutual Funds: Financial Reporting and Internal Controls Day 1
1Mutual FundsFinancial Reportingand Internal
ControlsDay 1
- Presented by
- Altaf Noor Ali
- Chartered Accountant
2Mutual 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
3Day 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.
4Tell 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.
5Group 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?
6Mf 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?
7Mf 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?
8Mf 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?
9Course 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.
10mf 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.
11Mutual 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
12Mutual 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.
13Mutual 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.
14Mutual 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.
15Investors 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
16Investors 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.
17Basic 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.
18Financial Reporting of Mutual Funds
19External 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
20External Financial Reporting
- Open-end
- Close-end
- The difference between certificates and units
- First Quarter
- Second Quarter Half-yearly.
- Third Quarter Three Quarters
- Annual Report
21External 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.
22Model 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
23Model 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?
24Model 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.
-
25Model 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. -
26Model 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. -
27Model 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.
-
28Model 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.
29Model 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.
30Model 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. -
31Model 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.
-
32Model 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.
-
33Model 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.
34Close-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.
35Model 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. -
36Model 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.
-
37Model 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?
38Model 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.
39Model 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. -
40Model 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. -
41Model 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.
42Model 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. -
43Model 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.
44Model 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.
45Model 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.
46Model 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.
47Model 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?
48Model 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.
49Model 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. -
50Model 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. -
51Model 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. -
52Model 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.
-
53Model 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. -
54Model 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.
-
55Model 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. -
56Model 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.
57Model 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.
-
58Model 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.
59Model 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.
60Model 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. -
61Internal 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.
62Critical 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.
63Critical 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.
64Critical 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.
65Critical 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.
66Critical 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.
67Critical 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 69Mutual FundsFinancial Reportingand Internal
ControlsDay 2
- Presented by
- Altaf Noor Ali
- Chartered Accountant
70Day 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.
71Mutual 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.
72Mutual 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.
73Mutual 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.
74MF 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.
75MF 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.
76MF 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.
77MF 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. -
78MF 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.
79MF 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.
80MF 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.
81MF 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.
82MF 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.
83MF 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.
84MF 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.
85MF 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.
86Role 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.
87Role 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.
88Role 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
89Key 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
90MF Financial Reporting and Internal Controls
- We request your feedback about this program.
91MF 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