Numbers, they say, tell the real story of financial success. If that's true, the mutual fund business in Pakistan is roaring out a tale of triumph.

Here's why: In the last two years, the sector has more than tripled in size to Rs112 billion in assets under management (as of December 31, 2004) and the number of funds operating has jumped from just a handful to 33 with many more in the pipeline.

On the face of it, this sounds like a financial fable in the making. But strip away the sheen of these glistening statistics and you're left with this reality: the bulk of this growth has come from weighty investments made by a few giant financial institutions, not a smattering of savings from thousands of doctors, shop-keepers and barbers that is actually the stuff of mutual funds.

Because mutual funds offer the advantages of diversification and professional management, they are an ideal tool for individuals to participate in stock and bond markets which are otherwise difficult to access.

In Pakistan, even the biggest private-sector funds have not been able to entice more than 5,000 individuals, less than 0.003 per cent of the population. Not exactly what you'd call glowing success. But it is early days yet. In fact it is only in the last two years that mutual funds have wrested control of a place of honour in the financial sector.

Until the nineties, the sector was made up of just two state-run asset management companies, NIT and ICP. At the time, a series of closed-end funds were established but most languished below par value, a result of poor management and a slack stock market. It was only in 1996 that the sector began to creep back to life with the establishment of Abamco, an asset management company in the private sector. Since then, NIT also underwent extensive reform by bringing on investment professionals and switching to a system of market-based quotations.

In 2003, ICP was broken up and privatized and the government plans to sell off NIT this year as well after breaking it into five individual funds.

The fortunes of the sector turned two years ago when other investment options grew less attractive. The government benchmarked the returns on National Savings Schemes to market-based rates, following which interest rates declined taking NSS returns down into single-digits. Then, the government also barred public sector enterprises from investing in NSS and decided to tax individuals on the income made through the schemes.

Moreover, the rupee gained stability making dollar investments less alluring. And as interest rates fell, bank deposit rates plummeted below the rate of inflation giving savers a negative return on their money. As the stock market raked in the gains of these changes, mutual funds began to flourish. Until 2003, growth stemmed mainly from the open-end variety of mutual funds. (An open-end fund sells units on a continuous basis and investors can buy or redeem units at the net asset value of the fund. A closed-end fund issues a limited number of shares which are then traded on a stock exchange.)

Of late, however, the growth in the sector has come largely from closed-end funds which at 19, now exceed the 14 open-end funds in business. But experts say this is not necessarily an encouraging sign. "Growth in closed-end is not natural growth because share issues are subscribed by institutions," says Habib ur Rahman, CEO of Atlas Asset Management which has Rs2.1 billion in assets. "Real growth will only be seen when it comes from retail growth and that spectacular growth has not yet come."

One of the biggest reasons for this is the failure on the part of asset management companies to work out the best way of distribution. Most of the bigger fund management companies hooked up with banks to sell their products but were unable to make much headway since bankers feared attrition in their own deposits.

More recently, Standard Chartered Bank has organized its distribution arm as a business and fund managers say its yielding results. Similarly, asset management companies like Al-Meezan which are subsidiaries of banks, are using their own branch networks for distribution. Now, funds plan to invest in their own outlets and sales teams.

The other reason retail growth has eluded funds is inadequate, or in many cases non-existent marketing. "People may have heard of Abamco in the cities but we don't have brand recognition nationwide," says Najam Ali, CEO of Abamco. "Mutual funds have so far thought that if their funds can perform, they will sell but performance has nothing to do with sales. What's needed is real marketing."

Despite plans to step up on marketing, funds are still likely to hit a few stumbling blocks along the way. One of the biggest will be the severely limited supply of investment professionals.

Then, fund managers also complain about the constraint of limited investment options. "Collecting money is easy but then where do you put it," says Naz Chohan, CEO of KASB Funds. "Real estate is not allowed, commodities are not allowed and there are no rules for private equity funds."

The government is working on new laws and permissions but fund managers say the pace of the work is slow. Fund managers have also recommended to the Securities & Exchange Commission and the State Bank of Pakistan to allow the investment of 5 to 10 per cent of assets in foreign stock and bond markets, to provide a wider array of investment options and asset diversification.

Those in the trade also worry about the paucity of tax incentives. Under the current tax law, investors get a tax break on up to Rs100,000 in investments per year. Mohammed Shoaib, CEO of Al-Meezan Asset Management Company suggests that this figure be raised to promote investment through mutual funds.

Industry experts say that if these snags are worked out, the potential for growth is immense. After all, investments in funds still amount to just five per cent of bank deposits compared to 20 per cent in India and more than 100 per cent in the US. Moreover, as National Savings Schemes become less attractive and funds mature, a good portion of the Rs900 billion nested there will eventually find its way into mutual funds.

The government's recent announcement about private pension funds going into operation from July 1 will also boost the sector. But will the sector continue to grow despite a booming market? Zahid Siddiqui, director of Flow (Pvt) Ltd, a distribution company that has sold Rs 800 million worth of open-end funds to corporations, says his company's sales have fallen 50 percent over the last two months. "With this stock market, it's not going to be easy to sell over the next 12 months," he says.

But fund managers say market performance is only barely relevant. "You always see peaks and troughs in a market and you have to ride them out," says KASB's Chohan. "The point is that this is a business to be in because with just 100,000 CDC accounts, it is obvious the capital markets are not penetrated at all."

As the industry grows, experts say the regulators will also have to step up on vigilance. "In the US, two issues have been seen," says Nasim Beg, CEO of Arif Habib Investments, which has Rs 13 billion in funds under management. "One is the timing issue and the second is preferential treatment by distribution companies in return for perks from asset management companies. So both these should be monitored here."

Moreover, industry sources say some asset management companies are funnelling cash from one fund into another and creating a web of intra-fund investment within their own group, which also needs to be checked. Until that happens though, the industry is bracing for big expansion.

Here's a sampling: Abamco plans to launch a capital guarantee fund, an aggressive asset allocation fund and a fund of funds by June to take its total of eight funds to 11. Similarly, Arif Habib Investments will launch a capital guarantee fund and an Islamic fund as well as a broad-based fund this year.

Al-Meezan will offer up to two to three new products before the year is out and United Asset Management Company says a capital guarantee fund is on the way which could be as large as Rs1 billion followed by a tracker fund.

Dawood Capital Management, with Rs1.3 billion in its sole money market fund has plans to launch a closed-end Rs500 million balanced fund later this month and then follow that with the introduction of a Rs300 million open-end Islamic fund and then a Rs500 million closed-end equity fund some 18 months down the road.

Moreover, several new players are also waiting in the wings for regulatory permissions to come through. KASB Bank, for example, has set up KASB Funds Ltd and plans to start business by the end of this year. And the big domestic banks are also said to be finalizing plans to get into the business as well.

That's why industry players are predicting the business will grow by 200 per cent over the next five years. An impressive number by any measure. But the real key to success will be how effectively mutual funds use marketing and distribution to make individual investors part of their tale. It's only if they can do that, that they'll be crafting a story of success.