Case for mutual funds: how they outperform savings accounts in times of high inflation

In this article, we will explore the potential benefits of investing in mutual funds as compared to savings accounts. Specifically, we will delve into the performance and offerings of Shariah-compliant money market and income funds available to investors.

Let’s begin our discussion by analysing the deposit numbers for banks and mutual funds in Pakistan.

According to the State Bank of Pakistan (SBP), the total banking deposits in the country as of January 2023 amounted to Rs22.75 trillion. Of this amount, approximately Rs10.2 trillion, or 45% of the banking deposits, were held in current, saving, and TDR accounts belonging to individuals.

As per the latest Islamic Banking Bulletin published by the SBP (September 2022), Islamic banking deposits in the country have reached Rs5.02 trillion, with a 21% share in the overall banking industry’s deposit.

This figure includes customer deposits of Rs4.57 trillion, with a significant portion of these funds remaining idle in current and savings accounts. Around Rs1.878 trillion is currently lying dormant in current accounts, while another Rs1.688 trillion is held in savings accounts.

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In Pakistan, Islamic banks enjoy a lower cost of deposit since there is no Minimum Deposit Rate (MDR) requirement on Islamic Banking Institutions, which is currently applicable only to conventional commercial banks in Pakistan. As per the circular issued by the SBP, banks are obligated to pay at least 50bps below the prevailing SBP Repo Rate (Interest Rate Corridor – Floor) i.e. 15.5% to their depositors.

In contrast, the total assets under management (AUMs) of mutual funds in Pakistan have reached Rs1.47 trillion as of January 2023. Of this amount, Shariah-compliant asset management holds Rs.665 billion, representing approximately 45% of the total AUMs.

Break-up is as follows:

Photo: Al-Meezan Investments/FMRs

Now the most basic question: what is Shariah-compliant mutual funds, and how can it be explained to someone who is unfamiliar with these concepts?

Islamic mutual funds are an investment vehicle that allows individuals and corporate investors to pool money regardless of their financial status for the purpose of investment to earn Halal profit governed by the requirements of Shariah law under the supervision of Shariah Advisors.

It is one of the attributes of mutual funds that irrespective of investment size everyone will get the same return on investment.

Islamic mutual funds conduct their operations under the principals of Wakalat al-Istithmar hereby Islamic asset management companies (AMCs) manage funds on behalf of their customers. This involves providing agency (wakala) services against specific fund management fees.

What are some low-risk investment options that are Shariah-compliant and available for investors?

Money Market Funds: They are an excellent alternative to bank accounts due to their higher profit rates and lower management fees.

These funds do not require a holding period and can be redeemed on the same day basis without any penalty or back-end load on withdrawals, unlike Fixed Term Deposits. Some of these funds also offer daily dividend facility mainly for Corporates for tax efficiency and better liquidity management.

The allocation in money market funds mostly consists of liquid assets like bank deposits, placements, Islamic Corporate Sukuk, and Islamic Commercial Papers.

The weighted average maturity of the fund is restricted to a maximum of 90 days as per the regulations to protect investors from any significant interest rate volatility.

The minimum investment amount is Rs5,000, and subsequent investments can be made in increments of Rs1,000. However, investment limit is higher in daily dividend funds.

Islamic Income Funds: are diversified portfolios of short to long-term Shariah-compliant GOP and Corporate Sukuk. Income Funds offer investors a way to gain exposure to a variety of debt securities without owning them individually. The minimum investment amount is Rs. 5000, and subsequent investments can be made in increments of Rs. 1000. These funds are ideal for investors with a medium to long-term investment horizon, such as child education, marriage or Hajj plans.

Shariah Compliant Sovereign Income Funds: They are a sub-category of income funds with a minimum requirement to hold at least 70% of investments in Government Securities. Due to their asset allocation, these funds are considered highly liquid and of the highest quality.

Liquid Islamic Income Funds: Liquid Islamic Income Funds are similar to Islamic Money Market Funds in terms of their allocation, with a more diversified range of Islamic financial institutions for deposits and placements. This category was recently introduced by Shariah-compliant asset management companies and became an instant hit in the retail segment as they offer higher returns compared to money market funds.

Islamic Fixed Term Plans: These come with fixed maturity periods ranging from 1 to 6 months. They are similar to the Term Deposit product offered by banks, with profits better than money market funds. A pre-encashment fee is applicable to these funds to discourage investors from withdrawing funds before the maturity date.

Shariah Compliant Pension Funds: These are long-term funds mainly intended to ensure a comfortable and hassle-free post-retirement life. This is a flexible fund with a range of investment options based on the risk-return profile of each investor. Takaful benefits are added free of cost (up to a certain limit) to protect the investor from any kind of financial crisis in the case of natural, accidental death or permanent disability.

There are more categories-based investments goals (risk-return trade-off), like equity funds, commodity funds, ETFs, Index tracker funds, sector specific equity funds, aggressive fixed income funds, fund of fund, capital protected schemes, balanced (hybrid) fund, and asset allocation funds etc.

Why prefer mutual funds over maintaining a savings or current account?

According to the SBP, the weighted average deposit rate for banking deposits over the past 12 years has been 4.5%, which is well below the average inflation rate of 7.9%.

Recent data shows that the average 6-month deposit rate stands at 7.51%, while 1HYFY23 inflation is at 25.4% resulting in a negative real return of around 18%.

On the other hand, the average YTD-23 returns of conventional money market funds were reported at 15.62%, while the average Shariah-compliant money market funds offered a return of 14.84%. These results make mutual funds a compelling choice for investors seeking better returns.

In the current high interest environment, it is challenging to outpace inflation, particularly for Shariah compliant investors, who face limited options for securities that can reflect changes in yield immediately after the monetary policy. In contrast, the conventional market quickly reflects any changes in interest rates in the T-Bill yields.

However, in the month of February, investing in Islamic Money Market (Cash) or Liquid Islamic Income funds may provide reasonable and much better returns compared to saving accounts in the range of 14.50-15.50% annualised.

How does removal of tax benefit for individuals in Budget 2022-23 impact mutual funds?

Investors have been continuously shifting away from banking and other channels to mutual funds following the budget of 2022-23, resulting in a significant surge in the sector’s growth. This trend can be attributed to several factors, including a broad range of products, competitive returns, and an uptick in financial literacy.

The AUMs of fixed-income funds, both conventional and Islamic, have seen a substantial increase of Rs254 billion since June 2022, with much of the growth being led by Shariah Compliant Income and Money Market Funds.

As a result, the Asset Under Management of Shariah Compliant Funds has experienced a staggering 49.3% increase, equivalent to Rs195.4 billion, bringing the total to Rs592.1 billion.

Photo: Al-Meezan Investments

An additional factor contributing to the growth of mutual funds is the recent requirement for all scheduled commercial and Islamic banks to maintain an Advance to Deposit Ratio (ADR) of over 50% by December 31, 2022.

This is an effort to discourage banks from investing in government securities and encourage them to lend to the real economy. If banks fail to comply with this requirement, a higher tax rate of 37.5% is applied to their total income instead of the standard 35% tax rate.

As a result, banks have been faced with the choice of increasing their lending in a high-interest-rate environment or shedding their high-cost depositors. Many banks have opted for the latter option, which has created an opportunity for mutual funds to expand reach and increase market share.

It is important to consider the potential unintended consequences of this regulation on the banking sector and the wider economy.

Forcing banks to increase lending could lead to higher levels of non-performing loans, while requiring them to reduce deposits may result in increased currency circulation, potentially fueling the growth of the cash-based black market. Data suggests that the ADR regulation may not be having the desired effect to restrict banks to invest in risk-free instruments like Government securities as the Investment to Deposit Ratio (IDR) currently stands at 85% (Jan-23) compare to 76% in June-2022. This may be due to the CentralBank injecting more money into the system through OMO to finance government debt.

According to the SBP, total banking deposits decreased by Rs59 billion in the last four months, with individual banking deposits falling by Rs118 billion. In contrast, the asset under management (AUM) of total fixed income mutual funds increased by Rs168 billion during this period, with the majority of the growth seen in the Shariah Compliant segment, which grew by Rs.143 billion.

Photo: SBP/Al-Meezan Investments


While mutual funds in our country are still in the early stages and lag behind our neighboring countries and developed western countries, they are becoming a popular investment choice among individuals due to their many advantages. These benefits include professional management, diversified product lines to cater to different needs, a simple and easy investment process, being technology-friendly, and offering more tax efficiency compared to traditional investment options like bank deposits or fixed placements.

The article is meant for general information purposes only and should not be taken as investment recommendation. It is important to remember that mutual fund investments are subject to market risks. Experts recommend that you carefully read all scheme-related documents to ensure the investment aligns with your risk-return profile.

The article does not necessarily reflect the opinion of Business Recorder or its owners