For the last few years, Pakistan has been desperately trying to change public perception, both at home and internationally, about its economic stability. After decades of being seen as an economic pariah state, its economic fundamentals have improved vastly. Ratings agency Standard & Poor’s upgraded Pakistan’s sovereign credit to single B+ two years ago, and the government says it is eager to attract as much foreign direct investment as possible. Last year it launched an Islamic bond on the international capital markets so that it could expand the country’s investor base.
But the Securities and Exchange Commission (SEC) in Pakistan has also set its eyes on making domestic reforms. It launched plans for a voluntary pensions system in the middle of last year. Industry participants say the move was badly needed.
In the US, mutual fund companies command assets that are about four times the size of the country’s bank deposits. In Pakistan, it is closer to 4%. On a GDP basis, assets under management in Pakistan are roughly 2%, compared with 6.2% in India and 121% in the US.
“You can get a sense of just how underdeveloped the savings market is. It is also reflective of the fact that there is a shortage of experience in the industry, and expertise in terms of competent investment managers,” explains Muddassar Malik, chief executive of BMA Asset Management, a Karachi-based firm.
The firm has just launched the BMA Pakistan Opportunities Fund. It is the first ever open-end US dollar-denominated offshore equity fund for institutional investors abroad who want to take advantage of Pakistan’s recent economic success. Malik says there has been “a great sense of jubilation that these reforms are taking place, and that the private sector is getting an opportunity to participate in the growth.”
There is another reason why the reforms are so important. Currently, most of the working population is employed either in public or private jobs, and entrepreneurial occupations are relatively low, explains Nasim Beg, who is chief executive of Arif Habib Investments and one of the members of the SEC task force that was set up to design the new scheme.
The bulk of the rural population in Pakistan, and low income groups are totally reliant on family support after retirement. Government employees, such as civil servants, armed forces, and so on, are offered defined benefit schemes.
However, these are unfunded pensions paid out of the government’s current budget. It is proving to be a huge strain, with mounting liabilities. Private firms, on the other hand, offer financial compensation structures, often linked to employees’ length of service with the company. They offer gratuity schemes, or provident fund schemes, where there is no portability, and where employees can draw down their savings and also effectively borrow against them. “So you might end up spending it all, and for practical purposes it is not really a retirement scheme,” explains Beg.

The new voluntary pension system will allow taxpayers to deposit up to 20% of their annual earnings into a pension saving scheme, through an exempt-exempt tax (EET) regime, which allows tax exemptions on contributions and investment income, but then taxes members’ benefits when they draw down. Upon retirement, between the ages of 60 and 70, members can either put the funds into an annuity with an insurance company, or leave the funds with asset managers to provide an income drawdown.
Life insurance companies as well as fund managers can set up these new pension schemes. “The life insurance companies are a bit reluctant; they have certain issues with the current structure, because of the sales commissions they can pay out is limited,” says Beg. The system allows for a maximum front-end sales load of 3%, with a maximum investment management fee of 1.5% per year.
Fund managers, meanwhile, are still being vetted by the SEC, although Beg believes that licences will begin to be handed out any day now. Each fund manager offering the scheme will have to provide three sub-funds, in equity, debt, and money markets.
“Each individual investor can make a decision on how the fund should be allocated within these sub-funds, with a few restrictions,” explains Beg.
After five years of successfully managing these funds, the government proposes that fund managers could start offering real estate and other asset classes.
Equity sub-funds must remain at least 90% invested in listed shares, while debt sub-funds are allowed to have a maximum weighted average duration of 10 years.
At least 50% of debt must be invested in federal government securities. The money market fund, in turn, is not to carry a duration of more than one year.

If it seems like there is a lot of hand-holding of managers, it is because there are comparatively few managers with experience in Pakistan. “Right now, it’s only the rules that have been drafted. From an educational point of view, it’s going to take time. The SEC is providing several educational seminars to foster an atmosphere of learning, so practitioners can understand the issues that are involved,” says Malik.
There is also the issue of peer group benchmarking. The SEC will be publishing the comparative performance of the fund managers. If a fund manager underperforms the peer group by more than a certain degree, there will be a penalty, either in the shape of a fine or, in more extreme cases, the cancellation of the licence of the asset manager.
Beg dismisses the argument that peer group benchmarking might create closet indexers or a herd mentality within the group. “If you are investing in Pakistan and the economy takes a downturn, can you blame the fund manager? Unless you are allowed to put the money anywhere in the world, then you might handle it better. That is why measuring against the peer group is the best measure you have, rather than having some absolute number that you have to reach.”
In fact, the government is allowing some general purpose funds to invest 30% overseas, precisely because of the small universe of stocks domestically. “The state bank has given us permission to put our money abroad, and we will be one of the first people coming out with a fund that invests internationally,” says Beg.
He adds that investors, both in Pakistan, and the Middle East, have an appetite for Shariah-compliant, or Islamic funds. “There are a couple of Shariah funds here, but they are trying to deal with the fact that a Shariah or an ethical fund will automatically reduce your universe. In Pakistan, only 10% of the 600 stocks fall into the Shariah-compliant category.”
BMA Asset Management’s Malik says that having peer group benchmarking is one of the controversial elements of the new system, and is the kind of issue that needs to be thought through more clearly. “If you cancel somebody’s licence, then where are those pensioners going to go?” he asks.
Still, it is early days and Beg points out that the market is not yet mature. “There are only a few fund managers at the moment, so we are restricted,” he says.

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