Interview with Khashe Ahmad Lodhi, Head of Islamic Funds at UBL Fund Managers
UBL Fund Managers Limited(UBLFM)is a wholly-owned subsidiary of United Bank Limited, making it the first asset management company to be launched by a bank in Pakistan. UBLFM has been operating since the year 2002 and are currently ranked number 1 in both assets under management (AUM) in fixed income schemes and in terms of AUM of private sector open-end mutual funds (out of 35 existing companies). UBLFM has been awarded a Management Quality Rating of AM2 Minus by JCR-VIS Credit Rating Company Limited.
Khashe Lodhi is head of Islamic funds at UBLFM. Prior to this, he was vice-president in the investment banking division at Pakistan Kuwait Investment Company. At Pak Kuwait, he was instrumental in the formation of an asset management company and a brokerage company. He was also a director in these companies. He has first-hand knowledge and experience of both fixed income and equity markets. Lodhi started his career in 1993 with Crescent Investment Bank Limited as a fixed income dealer in the treasury and funds management department. In 1996, he moved to the equities side as a dealer in the capital markets department. Later on, he became chief dealer and head of capital markets and managed a fund of over Rs6 billion. He has also worked for Mashreq Bank Pakistan, Crescent Commercial Bank and PICIC.
Lodhi is an MBA graduate from Institute of Business Administration (IBA). He is also a visiting faculty member of IBA and has taught courses in finance including portfolio management.
UBLFM has developed the United Composite Islamic Fund (UCIF) as well as the United Islamic Income Fund (UIIF). How are their approach different from others and what is the overall proposition for investors?
UCIF is an open-ended fund that offers its investors an opportunity to invest in a diversified portfolio of Shariah-compliant investments with the objective of maximising medium- to long-term returns for a given level of risk. The investments in the fund are diversified both in terms of securities within an asset class as well as across asset classes. UCIF is a composite fund that invests in both equities and fixed income instruments. On the equities side, the fund can invest in all the Shariah-compliant companies listed on KSE-100 Index. On the fixed income side, the fund can invest in all the Shariah-compliant fixed income securities. The fund can also invest in Shariah-compliant equities and fixed income securities outside Pakistan.
The benchmark of UCIF is 50% Dow Jones-JS Pakistan Islamic Index plus 50% of the average fixed income Shariah-compliant deposit rate of different Islamic banks. The rationale behind this benchmark is that it totally encompasses both the equities and fixed income portions of the fund.
UCIF is the only composite fund in the mutual fund industry in Pakistan. It offers unique features of both equity and fixed income to its unit holders. Being a composite fund, UCIF offers a leeway to the fund manager to continuously switch its investments between equities and fixed income depending on the available return while keeping in mind the associated risk. This helps the fund manager in enhancing the return of the fund for a given level of risk.
An open end mutual fund, UIIF on the other hand endeavours to provide attractive returns to its investors by investing in Shariah-compliant income instruments while taking into account capital security and liquidity considerations. The fund can invest in all Shariah-compliant fixed income securities within and outside Pakistan.
The benchmark of UIIF is the average of 6-month placement rates of three Islamic banks. The rationale behind this benchmark is that it reflects the major portion of investments of the fund in the absence of significant asset classes. The benchmark is likely to change as the Islamic market further develops and more investment opportunities in diversified asset classes become available.
UIIF offers following two types of units to its investors:
Income units which are suitable for investors who desire a source of regular income while also aiming to preserve capital.
Growth units which are suitable for investors who seek capital appreciation as their funds are automatically re-invested.
How would you characterise the investment/management style that governs UBL funds? What do you bring to your Shariah-compliant offerings that is different from the rest?
The investment philosophy of UCIF is medium risk - medium return and buy-and-hold. On the equities side, a fine blend of value, growth and dividend stocks is maintained in the fund so as to diversify the portfolio and minimise risk. On the fixed income side, the fund aims to maximise annual income for the investors while preserving the capital.
The investment philosophy of UIIF is to maximise annual income for the investors and to preserve the capital while keeping exposure in a blend of short-, medium- and long-term income instruments. The fund aims to outperform the benchmark as well as its peer income group funds.
With regards to your equity fund (UCIF), what sort of a selection/filtration process does a stock go through before you invest in it? What kind of research do you put into selecting stocks and the sectors at large?
On the equities side, the fund manager, in close liaison with the research analysts, identifies securities that offer a blend of value, growth and dividends as well as significant upside in their values as compared to their fair values. The research analysts carry out thorough research and detailed credit evaluations and based on that research give their recommendations to the investment committee (IC). The final approval rests with the IC and the fund manager invests after the final approval. If a security is trading at a discount of up to x% to its fair value, it becomes a ‘BUY’.
A universe of approximately 50 listed companies is maintained with updated earnings and valuation expectations.
How concentrated is the UCIF portfolio? And to what extent do you plan on diversifying it – in terms of number of stocks as well as across sectors?
UCIF portfolio is well diversified both in terms of securities within an asset class as well as across asset classes.
As of 31 December 2007, the equities section of the UCIF portfolio had 24 scrips that represented 14 different sectors of the KSE-100 Index.
As of 31 December 2007, the net assets of the fund were PKR1,055 million and the following were the top ten scrips in the portfolio as a percentage of net assets:
% of Net Assets
Fauji Fertilizer Company
Oil & Gas Development Company
Pakistan Telecommunications Company Limited
Meezan Bank Limited
Fauji Fertilizer Bin Qasim
DG. Khan Cement
Pakistan Petroleum Limited
Pakistan State Oil
Pakistan Oilfields Limited
Going forward the fund manager will keep on diversifying by adding more scrips that offer significant upside in their values as compared to their fair values. If a security is trading at a discount of up to x% to its fair value, it becomes a ‘BUY’.
What is the typical holding period for a stock in UCIF? How often are these allocations revised, and what is the turnover rate for the overall portfolio?
UCIF is a long-term fund and usually holds stocks for a minimum period of one to three years. Stocks are only offloaded earlier; in the case of the following scenarios:
If a security is trading at a premium of up to x% to its fair value, it becomes a ‘SELL’
Dismal financial results of the company; due to any reason that can further affect the future performance of the company
Change in government regulations that can affect the price of the scrip
Increase in price risk, market risk, settlement risk or liquidity risk
Stock and sector allocations in the fund are revised in IC meetings which are held on a regular basis (at least once every quarter). In case of extreme circumstances, the allocations are also revised through IC approvals by circulation.
With regards to your income fund (UIIF), what are the target levels of return and volatility? How is this risk-return performance evaluated considering the limited number of Shariah-compliant benchmarks and peer groups?
The investment philosophy of the fund is medium risk - medium return and buy-and-hold.
The aim of the fund is to maximise annual income for investors and to preserve the capital while keeping exposure in a blend of short-, medium- and long-term income instruments.
The fund aims to outperform the benchmark as well as its peer income group funds without taking undue risks.
The benchmark of UIIF is the average of 6-month placement rates of three Islamic banks. The rationale behind this benchmark is that it reflects the major portion of investments of the fund in the absence of significant asset classes.
The benchmark is likely to change as the Islamic market further develops and more investment opportunities in diversified asset classes become available.
The UIIF was launched recently and follows the worldwide spotlight on fixed income allocations (in particular with regards to sukuk). What are the essential components required to develop a successful sukuk investment programme?
Any new sukuk investment proposal is thoroughly reviewed taking into account the following:
Purpose of sukuk issue
Sukuk structure and pricing
Background of sponsors
Cash flow analysis of the company
Principal repayment structure
Secondary market for the sukuk
Given that the fund has a very short track record to boast, what are the key characteristics that make the UIIF a viable investment? Does the rationale work for both local as well as for overseas investors?
Even though UIIF has just been launched in October 2007 and does not carry a long track record, it is a product of UBLFM which carries the following strengths:
Successful brand name of parent company “United Bank Limited”
Professional fund management team
Strong in-house research expertise
Experienced finance, operations team
Strong corporate and retail sales team
Strong risk management systems
Investment centres across Pakistan
Sale of units of UBL funds in GCC through UBL branches
Proposed sale of units outside Pakistan in US dollar denominated funds
Also, in the case of UIIF, the following are the added advantages for both local as well as foreign investors:
Quality assets in the portfolio
Growth in fund size
Better comparative returns vis-à-vis benchmark and peers
UIIF offers income units as well as growth units for the investors
Given your expected risks and returns for your portfolios, what sort of an investor-profile are the funds ideally suited for?
The target markets are:
Provident funds/pension funds/gratuity funds
Islamic banking and non-banking financial institutions
Takaful insurance companies
High net worth individuals looking for Shariah-compliant income
Islamic foundations, trusts, etc
How do the funds manage risks – those associated with targeting one specific market segment or otherwise? Do the fund allocations retain geographical flexibility? If so, what would be a typical breakdown invested in and outside of Pakistan?
The following risks are continuously monitored by the investment management and risk management and compliance departments:
Government Regulation Risk
Voluminous Purchase/Redemption of Fund Units Risk
Value At Risk (VaR)
The fund manager and the senior management have ready access to the management information system reports. They continuously monitor the fund for risk management and compliance.
To proactively manage risk, there are stop-loss limits for the trading portfolio of the funds. The stop-loss limits are determined after taking into consideration the current market conditions and macro variables. The limits are decided before the trading hours and are duly approved by the CEO and CRO.
Recently a separate risk management department has been put in place in UBLFM and the risk team is working towards the development of VaR risk limits to mitigate the risks in a proactive manner.
There will be three layers of risk monitoring for both debt and equity transactions:
Trade risk monitoring
Stock market risk monitoring (KSE-100, KSE-30 and IC Basket)
Portfolio risk monitoring (both debt and equity instruments)
Some of the following tools are already in use and some are being worked upon to measure risk:
A predictive model created by Edward Altman in the 1960s. This model combines five different financial ratios to determine the likelihood of bankruptcy amongst companies.
Generally speaking, lower the score, higher the odds of bankruptcy. Companies with Z-Scores above 3 are considered to be healthy and, therefore, unlikely to enter bankruptcy. Scores in between 1.8 and 3 lie in a grey area.
The risk team uses the Z-Score analysis for credit evaluations and equity investments.
All financial ratios are calculated for each investment proposal and a periodic review is carried out of investments in all asset classes. These ratios include income ratios, profitability ratios, net operating profit ratios, liquidity ratios, working capital ratios, bankruptcy ratios, long-term analysis, coverage ratios, total coverage ratios and leverage ratios.
The risk team is also working towards the development of risk indicators for each fund which will be as follows:
Beta (already being reported in the monthly fund manager report)
Sharpe Ratio(already being reported in the monthly fund manager report)
Tracking error VaR
Portfolio VaR for each fund
Fund VaR (already being reported in the monthly und manager report)
Stress testing Techniques by applying maximum shocks to portfolio
All these indicators are prepared or are in the process of being developed by the risk team and are reviewed by the CRO and the risk committee.
UCIF and UIIF are both in the process of starting investments in the international markets and the risk management and compliance department has already started working on the risk management tools.
How are the two funds structured to comply with Shariah principles? How often is this reviewed and by whom?
All investments in UCIF and UIIFare made under the strict supervision of the Shariah Advisory Board (SAB) which comprises of Maulana Hassan Kaleem and Maulvi Najeeb Khan.
Maulvi Muhammad Hassaan Kaleem
Shariah advisor to AlBaraka Islamic Bank
Shariah board member of Pak Kuwait Takaful Company Ltd
Shariah council member of Inter Securities Islamic Fund
Completed Takhassus Fil Ifta and Alimiyyah from Dar-ul-Uloom Karachi, run by Justice Mufti Taqi Usmani
Mufti Muhammad Najeeb Khan
Shariah advisor to Habib Bank AG Zurich Islamic Branch Karachi
Specialisation in Islamic jurisprudence/Islamic finance (Takhassus/PhD equivalent)
Completed specialisation in Islamic jurisprudence majoring in Islamic finance, under Justice Mufti Taqi Usmani
Completed Almia certificate in Arabic and Islamic sciences (masters equivalent in Arabic and Islamic sciences)
The fund management team identifies investment opportunities and after initial due-diligence forwards the same to SAB for a review from the Shariah angle. If SAB approves the proposed investment then a thorough review and due diligence is made before sending the proposal to the investment committee (IC) for final approval. Investments are made after the final go-ahead from the IC.
The fund management team reviews all the investments in the fund after announcement of their periodic financial results and sends its recommendations to the SAB. The fund management team and SAB also keep on reviewing all the investments on a continuous basis for any deviations from Shariah angle and immediate actions are taken accordingly.
What is the investor make-up like for each of the funds? What types of investors have shown interest in the UIIF since its launch?
Other investors who have shown interest in UIIF include gratuity funds, pension funds, provident funds, investment banks, leasing companies and NGOs.