Chief Executive Officer
JS Investments AM2+ (Rated by Pacra)
“Finance sits in the middle, like the neck of an hourglass whose grains of sand are money and risk. Finance is a network that relies on trust.”
In a recent address, Gary Gensler[1] eloquently articulated the essence of finance- a network that relies on trust, a delicate interplay between those with money-seeking avenues for investment and those needing funds to fuel their aspirations. As asset managers, we play a central role in this complex orchestration, managing the sands of money and risk that flow through the hourglass.
If you’ve ever invested your savings in term or fixed deposits, you know the solace of stability they bring. Our newest offering, the ‘JS Fixed Term Munafa Fund,’ belongs to this secure category of financial instruments. However, before we delve into the appeal of fixed returns, we must acknowledge a fundamental truth highlighted in Gary Gensler’s speech – risk is an inherent part of finance. Despite the intrinsic capriciousness of markets, what risks could a product promising a fixed return at the end of a specific period pose?
In the face of soaring interest rates – a steep 600 basis points climb this year alone – the main risk is further hikes. Although by opting for a tenure of twelve months or less, investors can shield themselves from the whirlwind of short-term market shifts and therefore the TDR-style mutual funds have gained immense popularity in our domestic market. Nonetheless, given our outlook on interest rates, we consciously refrained from offering this product, preferring to focus on the JS Cash and JS Government Securities Fund or our JS Microfinance Sector Fund for medium-risk takers.
However, as we navigate through a global economic landscape riddled with uncertainties from geopolitical tensions, the pandemic’s aftermath, and inflationary pressures, we believe the interest rate trajectory is now shifting. Front-loading, which had become the motto of central banks by the end of 2021, is now signaling the end as most of them have either slowed the pace or halted them altogether. This is leading global experts to a consensus that interest rates have peaked, particularly as major economies cautiously adjust to prevent hindering economic growth. This global outlook is significant for investors in Pakistan, providing valuable insights into the likely path of local interest rates. Although I will delve into our local context in subsequent paragraphs, this potential stabilization offers a strategic opportunity for investors eyeing fixed-return options. Locking in returns for an extended period, particularly in a climate where interest rates might not climb further, could be a wise move.
JS Fixed Term Munafa Fund – Plan I & II
JS Fixed Term Munafa Fund, launching its Initial Public Offering on December 26, 2023, and accepting applications until January 8, 2024, offers two attractive plans. Plan 1 promises a 17.5%* return for a 3-year** commitment starting January 8, 2023, while Plan 2 provides a 21.0%* return for a 12-month term** starting the same date at a moderate risk profile. The 17.5%* rate for three years is exceptionally enticing for those who can forego immediate cash needs. While the 21%* yield for one year is quite attractive, it’s imperative to recognize that investments maturing one year from now and beyond will be exposed to reinvestment risk. This becomes especially relevant in the current environment where interest rates have seemingly peaked.
Interest Rates in Pakistan: Peaked or Persevering?
The debate over the direction of interest rates in Pakistan is ongoing. Some argue that rates have peaked, pointing to the State Bank of Pakistan’s (SBP) policy rate stability. The SBP has been balancing the need to curb inflation with fostering economic growth, and recent policy rate stability indicates a cautious approach against aggressive rate hikes. Real interest rates are currently negative but are expected to stay this way for 3-5 months. Lately, SBP has consistently anchored the policy rate against 12-month forward inflation. However, barring a significant commodity price spike, CPI should fall below 20% in the third quarter of 2024.
There are skeptics, though. Fiscal deficits, poor tax collection, and a vulnerable rupee suggest that interest rates may not have peaked. This viewpoint is bolstered by the rupee’s fragility and the fact that real rates are still negative, with inflation as the primary concern. The debate extends to the potential for SBP rate cuts. While aggressive rate cuts might be contemplated, their feasibility is questionable in light of economic challenges.
However, we believe a more significant risk lies in delaying the locking in of yields at current levels. Those with excess cash and short-term investments beyond their standard allocation should consider rebalancing their portfolios, as the central bank is nearing the end of its policy tightening or is expected to do so in early 2024. Fixed Return Mutual Funds or higher-duration income funds offer superior income, valuations, and benefits to portfolio dynamics. They present an attractive alternative to short-term investments and haven’t been this appealing in over ten years.
Our investment strategy prioritizes the analysis of different scenarios and the evaluation of their effects in case of any deviations from our anticipated path. Recently, we conducted a simple analysis that predicted a decline in bond yields to approximately minus 100 basis points, which would result in a total return of over 19%. However, we recognize that there is also a real threat that insufficient policy tightening or other factors may prevent the recent decline in inflation, leading to further rate hikes and a rise in yields of about 100 basis points. In such a scenario, the decrease in bond prices would result in a 4.2% loss. These scenarios and their targets represent only a small fraction of the possible outcomes as we approach the end of the year and move into 2024. Nonetheless, they confirm our belief that the current risk/reward setup in our income funds is quite favorable.
The Case for Long-Term Fixed Return Mutual Funds
Against this backdrop, long-term fixed-return mutual funds are an attractive investment option for those seeking stability and long-term growth. Here are some key reasons why a long-term plan is advantageous:
Optimal Timing: The current stabilization of interest rates in Pakistan suggests that now is an opportune time to lock in favorable returns for an extended period. Unlike the unpredictable fluctuations of other investment types, these funds offer a consistent and predetermined return path.
Institutional Investors’ Perspective: Institutional investors, such as retirement fund managers or insurance companies, strive to identify a “minimum risk portfolio” when allocating funds. This portfolio is the blend of investments that meet the fund’s commitments with the least risk. Although private investors may not explicitly frame their investment plans in these terms, their objectives are broadly similar. While offering high-income certainty, cash and money market funds seldom provide returns that align with long-term savings goals, especially when those rates are transient. As inflation returns to optimal levels and short-term interest rates normalize, income funds are expected to offer returns equal to or exceeding their benchmarks. Investors with excess exposure to cash and short-term funds should consider extending the term and locking in the current yield with at least some of their surplus as we move past the peak in short rates. Recall times when retirees invested substantial sums at an 18% rate in National Savings Schemes for a lengthy duration.
Taxation Advantage: Beyond the economic scenario, investors should also consider the tax implications of their investment choices. Fixed-return mutual funds often enjoy more favorable tax treatment than traditional fixed deposits. In Pakistan, interest earned from fixed deposits is subject to withholding tax, which can significantly reduce the effective return. In contrast, capital gains from mutual funds may be taxed at lower rates, offering a more tax-efficient investment route.
Conclusion: Navigating Towards Financial Resilience
In conclusion, the current economic scenario presents a unique opportunity for investors to consider long-term fixed-return mutual funds. Understanding global and local economic trends and recognizing the potential for stability in local interest rates, combined with the tax advantages, enable informed investment decisions that align with financial goals. As we navigate a complex economic landscape, the wisdom lies in making choices that endure over time. Long-term fixed-return mutual funds, with their potential for steady growth and tax-efficient returns, offer a pathway toward financial resilience and prosperity.
Disclaimer:
All investments in mutual funds and pension funds are subject to market risks. Past performance is not necessarily indicative of the future results. Please read the Offering Document to understand the investment policies and the risks involved.
* The expected fixed rate of return mentioned above will apply from the launch date of the
plan(s) to the maturity date.
** Early redemption is subject to the deduction of contingent load, which shall be proportionate
To the net loss incurred due to early redemptions before the maturity of the plan(s).
