WITH the way cleared for the local financial markets to expand, securities dealers are anticipating that the mutual fund market will provide one avenue for shoring up their revenue streams following the Jamaica Debt Exchange (JDX).

The JDX saw the Government replacing high-interest bonds for those with lower yields and longer maturities. The exchange is expected to result in over $40 billion in interest savings for the Jamaican government.

A reduction in the net interest income from Government of Jamaica (GOJ) instruments means that the financial institutions, which hold more than half of government-direct debt, will have to diversify product and service offerings in order to remain profitable and many are looking to the mutual fund market to do this.

The recent decision to remove an over 11-year-old moratorium on the registration of new unit trust and unit trust products, has opened the way for new locally based collective investment schemes to be established and for financial institutions to benefit from the additional income source.

What’s more, the Government has committed to the International Monetary Fund (IMF) that it will make amendments to the Unit Trust Act that will come into effect by December 2010 and exempt mutual funds from onerous provisions in the Companies Act of Jamaica by December 2010.

Mutual funds allow investors to pool their money to invest in a portfolio of securities, usually either stocks or bonds or both, which is managed by an investment professional. There are three types of mutual funds: Equity funds or stocks, Fixed income funds, or bonds, and money market funds.

Mutual funds can offer diversification as the fund is invested in a broad range of securities and assets, and depending on the size, can access hundreds of different stocks in many different industries. In addition to the diversification benefits, there is the added convenience of an investor’s singular purchase being invested in many different assets.

General manager of Capital and Credit Securities Limited Christopher Walker told the Business Observer that among the benefits of the mutual fund is that it can match every investment profile and investor level and serve to remove the systemic risks to the financial companies that were formerly associated with the ‘repo’ products.

George Roper, deputy executive director of the Financial Services Commission, said the move to open up the mutual fund market also improves the outlook for more robust financial system stability. He said mutual funds can provide “additional avenues for securities dealers to progressively realign their business models, restructure their balance sheets to reduce their direct exposures to riskier instruments and to simultaneously provide alternative avenues for the generation of income from fees and commissions”.

Given the establishment of the appropriate regulatory framework, the institutions stand ready to take advantage of these opportunities. Steven Gooden, VP Investments and Trading, NCB Capital Markets, says NCB is ready for mutual funds.

“As a group, we are extremely focused where opportunities are concerned. As it relates to the mutual fund and unit trust market, our intention is to become a major industry player,” he said. “We have both distribution channels and the expertise to make this happen.”

Karl Lewin managing director of Barita Unit Trust Management Limited, also disclosed that while Barita is already a player in the small mutual funds market that existed locally, the company has already started to create additional products to take advantage of the expansion.

“We have a positive outlook, as the more the investing public gets accustomed to the mutual fund market replacing repos, the more individuals will be inclined to participate in the mutual fund market,” he said. “Our competitive strength rests in the fact that we have been in the market since 1993 and have already made a name for ourselves.”

Walker agrees that mutual funds can form an important part of an institution’s earnings.

“It can revolutionise the market, but when we know in what manner it will be addressed, then we will know the impact it will have on the market,” he said. “Indeed, the manner in which the mutual fund market will be developed has been a point of interest for many within the sector who have raised questions about the current and existing legislation, the extent of the regulation and the number of players within the market.”

“There is also the question of excessive fees which could be charged by regulators to operate in the mutual fund market. This would be to the detriment of investors,” Lewin added. “Overregulation of the mutual fund market may prove to be a hindrance. For example, the onus is placed on trustees of pension funds which may be a deterrent for individuals offering their services as trustees,” Lewin, told the Business Observer.

The mutual fund markets across the world are reportedly the most heavily regulated, because of the need for fund managers to maintain transparency, liquidity, an audited performance track record and the safety of investors’ funds. A lack of adequate regulation was one of the shortcomings of the financial sector identified by the IMF in its assessment of the local industry. However, Roper said that increased regulation is part of the wider financial sector reform of which the mutual fund market is a part.

“The FSC is currently undertaking a review of relevant legislation for regulating collective investment schemes with a view to strengthening the overall framework,” he said.

Executive director of the FSC Rohan Barnett last month disclosed that the aim of the increased regulation will not just allow for the development of mutual funds, but to also enable the securities industry to accommodate hedge funds and private equity funds aimed at the sophisticated investor.

However, there are other challenges facing the establishment of a vibrant mutual fund market locally. There is the stipulation by the Bank of Jamaica (BOJ) Act that securities dealers should not have more than a five per cent exposure to overseas assets. This ultimately limits the breadth of the market to at least 95 per cent of local assets. According to Walker this limits the possibility of a vibrant mutual fund market as local assets are neither available in sufficient quantities or adequately diversified.

The local equities market alone is limited to the just over 40 companies listed on the Jamaica Stock Exchange. These companies trade in only seven sectors: finance, communication, conglomerates, manufacturing, insurance, retail, tourism and a category called ‘other’ which comprises entertainment, fashion and government run entities.

However Roper confirms that the Stand-by Arrangement with the IMF effectively unhinged the sector and opened up the possibility for greater expansion. He said he could not speak to the five percent limit, but that reforms were taking place to deal with this and other issues.

“The Government has committed to removing these obstacles as part of the structural conditionalities under the Stand-By Arrangement agreed with the IMF. Notwithstanding these problems, current regulations allow for the registration and marketing of overseas-based mutual funds, and several such funds have been actively marketed to investors in Jamaica,” Roper said.