The Mutual Fund Company of the Philippines

8/2/2019 The Mutual Fund Company of the Philippines

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Performance Evaluation Report

Independent Evaluation Department

Reference Number: PPE: PHI 2011-16Project Number: 28714Equity Investment Number: EI 7125-PHIJuly 2011

Philippines: The Mutual Fund Company of thePhilippines

This report contains information that is subject to disclosure restrictions agreed between ADB and therelevant sponsor or recipient of funds from ADB. Recipients should therefore not disclose its content to thirdparties, except in connection with the performance of their official duties. ADB shall make publicly availablean abbreviated version of this report that will exclude confidential information.


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CURRENCY EQUIVALENTS(as of April 2011)

Currency Unit Philippine peso (P)P1.00 = $0.231$1.00 = P43.290

ABBREVIATIONS

ADB Asian Development Bank

ATRKE ATR KimEng Asset Management, Inc.

BSP Central Bank of the Philippines

CFMA Clemente Fund Management Asia

CIS collective investment scheme

CTF common trust fund

CTRP Comprehensive Tax Reform Program

ECC environmental clearance certificate

EROIC economic return on invested capital

ESG environmental, social, and governance

FIRR financial internal rate of return

FMAP Fund Managers Association of the Philippines

GDP gross domestic product

ICAP Investment Company Association of the Philippines

MFCP Mutual Fund Company of the Philippines

MFMCP Mutual Fund Management Company of the Philippines

PDEX Philippine Dealing and Exchange Corporation

PNB Philippine National Bank

PPER project performance evaluation reportPSE Philippine Stock Exchange

ROIC return on invested capital

RRP report and recommendation of the President

SDA special deposit account

SEC Securities and Exchange Commission (Philippines)

UITF unit investment trust fund

NOTES

(i) The fiscal year of the Mutual Fund Company of the Philippines ends on31 December.

(ii) In this report, "$" refers to US dollars.

Key Words

adb, asian development bank, capital market, equity investment, fund management,lending, investment company, mutual fund, mutual fund company of the philippines,philippines, private sector, securities, stock market.


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Director General H. Hettige, Officer-in-Charge, Independent Evaluation Department (IED)Director H. Feig, Officer-in-Charge, Independent Evaluation Division 1

Team leader N. Subramaniam, Senior Evaluation Specialist (Private Sector), IED

Team members N. Gamo, Evaluation Officer, IEDI. Garganta, Senior Evaluation Assistant, IED

Independent Evaluation Department, PE-744

In preparing any evaluation report, or by making any designation of or reference to a particularterritory or geographic area in this document, the Independent Evaluation Department does notintend to make any judgments as to the legal or other status of any territory or area.


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CONTENTSPage

BASIC DATA

EXECUTIVE SUMMARY i

I. THE PROJECT 1

A. Project Background 1B. Key Project Features 2C. Progress Highlights 2

II. EVALUATION 3

A. Project Rationale and Objectives 3B. Development Impact 4C. ADB Investment Profitability 14D. ADB Work Quality 14E. ADB Additionality 16F. Overall Evaluation 16

III. ISSUES, LESONS, AND RECOMMENDED FOLLOW-UP ACTIONS 17A. Issues and Lessons 17B. Recommended Follow-up Actions 18

APPENDIXES

1. Mutual Fund Industry Developments2. Private Sector Development Indicators and Ratings3. Review of the Fund4. Capital Market Overview

20252937

The guidelines formally adopted by the Independent Evaluation Department (IED) on avoidingconflict of interest in its independent evaluations were observed in preparing this report.Consultant Lisa Taber assisted in the analysis and preparation of the report. To the knowledge ofthe management of IED, the person preparing, reviewing, or approving this report had no conflictof interest.


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BASIC DATAThe Mutual Fund Company of the Philippines (Equity Investment 7125-PHI)

As per ADB InvestmentDocuments

Actual

Key Equity Investment Data ($ million)Approved Amount $3.85 million $3.85 millionSubscribed Amount $3.85 million $3.85 million

Key Dates ActualApproval of Concept ClearanceFact-Finding September 1995Management Review Meeting 29 November 1995Staff Review Committee Meeting 24 January 1996Board Approval 9 April 1996Signing Date of Legal Documents 15 April 1996

Disbursement Date 29 April 1996


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EXECUTIVE SUMMARY

In April 1996, the Asian Development Bank (ADB) made an equity investment ofP100 million (then equivalent to $3.85 million) in the Mutual Fund Company of the Philippines(MFCP), a new, open-end growth and income (balanced) fund investing only in the Philippinesand primarily in listed equities and fixed-income instruments of Philippine companies, as well as

in government debt obligations. The main objective of the investment was to catalyze thedevelopment of the nascent mutual fund industry in the Philippines and attract small savers tothe market, thereby increasing the domestic supply of capital for investment and growth. ADBsinvestment in MFCP was also expected to foster the development of secondary markets fordebt and equities.

ADB and six other founding shareholders invested a total of P430 million in MFCPbefore it was opened to public participation on 1 May 1996. Combining sales to individuals andinstitutional investors, the MFCP was targeting a fund size of P1.2 billion, according to the reportand recommendation of the President (RRP) of the proposed equity investment in the MFCP.

About a year after MFCPs launch, Philippine markets were struck by a series of

economic, political, and global shocks, the effects of which would not abate for 6 years. TheAsian financial crisis first caused a severe economic contraction in 19971998. After a briefrebound, Philippine markets were hit again by high levels of political instability (including apresidential impeachment), serious revelations of stock-market fraud, growing macroeconomicimbalances, a huge devaluation of the peso, and global eventsincluding the bursting of thetech-stock bubble in 2000 and the 9/11 terrorist attacks in the United States in 2001.

While these conditions affected market performance broadly, MFCPs results weregenerally more negative than those of other balanced funds or the benchmark index. By 2002,MFCPs net assets had eroded to less than half their initial value due to investment losses, largeredemptions from institutional investors (themselves under financial stress), and disappointingshare sales. The Mutual Fund Management Company of the Philippines (MFMCP), MFCPs first

fund manager, saw its capital fall below statutory requirements. As a result, in August 2003 itwas forced to sell a controlling stake in MFMCP to ATR KimEng Asset Management, Inc.(ATRKE), part of a family of global financial services companies in Asia.

Despite these initial problems, MFCPs fund manager has helped expand mutual fundsby participating in industry efforts to lobby the government for key regulatory reforms. Two of themajor hurdles to the growth of mutual funds identified in the RRPrules that effectively double-taxed capital gains on mutual funds and that prevented fund managers from managing morethan one fundwere eliminated in 1998. Since then, net mutual fund assets have grown by afactor of nearly 40. Since 1996, gross national savings have also increased dramatically, fromabout 18% to 40%. The bond market has grown by 25% per year since 2000 and corporateissues have increased from 2% to 12% of trades. However, serious deficiencies in the

regulatory framework have not been rectified. The regulatory and taxation rules that apply tovarious types of similar longer-term investments are very different. Companies and customershave to disentangle a complex web of rules before they can decide what to offer or purchase.

MFCP made only minimal contributions to the development of the mutual fund industry,to retail investor outreach and to the capital market development in the Philippines.Nevertheless, the patience of ADB as an investor in MFCP, which allowed for the continuedpresence of MFCP in the market, helped bring a degree of stability to the mutual fund industryat a very fragile time and enabled the entrance of ATRKE into the market. ATRKE has since


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earned competitive returns, set high standards for mutual fund operations, and been a leader inthe industrys efforts to hold companies listed on the Philippine Stock Exchange (PSE) to highergovernance standards. The projects private sector development impact is rated partlysatisfactory(All ratings are evaluated based on the criteria established in ADB's Guidelines forPreparing Performance Evaluation Reports on Nonsovereign Operations [2007]).

Though ATRKE has improved performance since the takeover, MFCP has earned areturn on invested capital of 3.22% since inception, compared with a compound annual growthrate of 5.62% for the benchmark index for balanced mutual funds. The projects businesssuccess is rated unsatisfactory. ATRKE has not been able to grow MFCPs capital base beyondits original amount, ending 2010 with only P500 million in net assets (while the industry hasgrown from P2.4 billion to P95.6 billion), nor has MFCP achieved substantial outreach. In 1998,the fund comprised 27% of all mutual fund accounts in the Philippines, but only 2% in 2010.Thus MFCP has had little impact on the participation of small investors in the mutual fundmarket.

The economic rate of return on invested capital (EROIC) for the MFCP investment iscalculated by using the return on invested capital and adjusting for fees and taxes paid. The real

EROIC for the project equals 0.26%, and since it is lower than the 5% set by ADB's guidelines,the contribution to economic development of the operation is rated unsatisfactory.

The subscription agreement signed between ADB and MFCP on 15 April 1996 requiresthe fund manager to review an investees level of compliance with environmental laws,regulations, and standardsincluding those relating to environmental impact assessments andinvoluntary resettlementbefore it purchases any security for the first time or when makingsubsequent purchases. MFMCP and ATRKE have complied with the requirement to review aninvestees compliance with environmental laws, regulations, and standards by periodicallyobtaining a list of environmental clearance certificates provided by the EnvironmentalManagement Bureau, and making sure that a certificate has not been denied to any company inwhich the fund has an equity position.

Given the ratings described above for private sector development, business success,contribution to economic development, and environmental, social, health, and safetyperformance, the projects overall development impact is rated partly satisfactory.

In April 1996, the value of ADBs investment in MFCP was P100 million (equivalent to$3.85 million at the time). As of 31 December 2010, the value of ADBs investment wasP168 million ($3.83 million equivalent), which generates a financial internal rate of return (FIRR)of2.1% in real pesos and0.04% in dollars. According to ADB guidelines, since these returnsare lower than 0.7 times the expected net FIRR of 23% in dollar terms in the RRP, the project israted unsatisfactoryfor ADB investment profitability.

ADB work quality is rated satisfactory. The initial design of the investmentunderestimates the effects of tax and regulatory disadvantages. The projects RRP placesemphasis on the funds expected benefits to small savers, but does not define this group or setany targets by which to measure success. The RRP also overestimates the returns theinvestment would achieve. However, while the rationale for the project and its initial designsuffered from overly optimistic assumptions, the operation was a rather unique attempt on thepart of ADB to intervene proactively in a severely underdeveloped and key part of the financialsystem, and screening, appraisal, and structuring are rated partly satisfactory.


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After the investment had been made, ADB was very engaged in oversightattendingboard meetings and keeping close track of the fund and the fund manager. Project recordsshow frequent communication between the fund and ADB staff seeking to clarify data or askingfor additional information. Anticipating its eventual divestiture, ADB resigned its board seat in2006 but continues to participate as an active board observer. Monitoring and supervision arerated satisfactory.

ADBs long investment in MFCP has contributed to the funds survival and prevented amore serious industry free-fall in 1997. ADB also reportedly encouraged MFCP to develop thecomprehensive operations manual that was used by the Securities and Exchange Commissionof the Philippines to assist other companies in the process of setting up mutual funds; to fullydisclose risks to potential investors in the prospectus; and to adopt a code of ethics. ADB's roleand contribution are thus rated satisfactory.

ADBs investment probably played an important role in getting MFCP off the ground in1996. ADB was one of the largest and most respected of MFCPs founding shareholders and itsparticipation may have been key, in early 1997, to attracting other investors. ADBs additionalityis rated satisfactory.

There are still many barriers to the development of the mutual fund industry in thePhilippines. Foremost among them is the lack of a transparent and equitable regulatoryenvironment due to the extremely opaque and uneven treatment of different but very similartypes of competing mutualized investment products, including mutual funds, trusts, insurance,and pre-need products such as college saving plans. Also, lack of financial understanding isperceived as a key constraint to the growth and widespread consumer uptake of mutual funds.Personal investment is still a new concept in the Philippines and consumers lack basicknowledge about the safety, liquidity, and potential returns of different investment options.

The following actions are recommended to follow up on the goals and achievements ofthe MFCP investment:

(i) ADBs exit from MFCP should be gradual. ADB controls a large share of thefunds net assets (34%). Abrupt divestment would cause a precipitous drop in

ATRKEs fee income, which could hurt its ability to manage the fund. It could alsoalarm other investors and trigger a wave of fund redemptions.

(ii) Any future ADB policy analysis and dialogue on capital market development inthe Philippines could include issues relevant to the development of the mutualfund industry.

Hemamala S. Hettige

Officer-in-ChargeIndependent Evaluation Department


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I. THE PROJECT

A. Project Background

1. In April 1996, the Asian Development Bank (ADB) made an equity investment ofP100 million (then equivalent to $3.85 million) in the Mutual Fund Company of the Philippines

(MFCP), a new, open-end growth and income (balanced) fund investing only in the Philippinesand primarily in listed equities and fixed-income instruments of Philippine companies, as well asin government debt obligations. The main objective of the investment was to catalyze thedevelopment of the nascent mutual fund industry in the Philippines and attract small savers tothe market, thereby increasing the domestic supply of capital for investment and growth. ADBsinvestment in MFCP was also expected to foster the development of secondary markets forcorporate debt and equities.

2. When the investment was approved, there were only six other mutual funds operating inthe Philippines. Net mutual fund assets totaled less than 0.01% of gross domestic product(GDP). Industry growth had long been stifled by restrictive regulations, and the Securities andExchange Commission (SEC) of the Philippines suspended new licensing altogether in the

1970s because of unsuitable market conditions. Not until 1989 were rules issued that permittedthe establishment of new mutual funds, but unfavorable tax and regulatory treatment limited themarket to very few entrants.

3. In 1994, Clemente Capital, a successful asset management company based in NewYork and founded by a Filipina national, Ms. Lilia Clemente, approached ADB with the prospectof investing in MFCP. As part of an ongoing policy dialogue and program of support to thePhilippine government, ADB was in the process of preparing a $150 million Capital MarketDevelopment Program Loan1 to address key regulatory issues that constrained the growth ofstock and bond markets. The MFCP investment was viewed as an opportunity to complementthe program of regulatory reforms by fostering the growth of mutual funds and stimulatingtrading on secondary markets.

4. ADB and six other founding shareholders invested a total of P430 million in MFCPbefore it was opened to public participation on 1 May 1996. The company that originallymanaged the fundMutual Fund Management Company of the Philippines (MFMCP)was setup in July 1995. Clemente Fund Management Asia (CFMA), an affiliate of the New York-basedClemente Capital, contributed 35% of MFMCPs initial capital, the Philippine National Bank(PNB), a state-owned commercial bank, put up an additional 35%, and two other institutionalinvestors contributed the remainder.2MFMCP earned standard fees equal to 2.15% of MFCPsnet assets in exchange for expanding the fund through new share sales, administering accounts,and managing fund assets.3

1ADB. 1995. Report and Recommendation of the President to the Board of Directors: Proposed Loan to theRepublic of the Philippines for the Capital Market Development Program (Loan 1363). Manila.

2National Investment Trust of China and Japan's Daiwa Asset Management.

3MFMCP agreed to reduce the management fee component of its overall fee by 0.5% to 1.0% for the first year ofoperation to make the fund more attractive than its competitors. The other fee components include 0.5% fordistribution and 0.15% for administration. After the first year, MFCPs management fee went up to 1.5%, thus itstotal fee was and still is 2.15%.


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B. Key Project Features

5. MFCP was launched in 1996 as an open-end mutual fund with the investment objectivesof preserving shareholders principal, generating current income, and promoting long -termcapital growth by investing in a balanced portfolio of equities and fixed-income securities issuedby Philippine companies, and debt issued by the government.

6. MFCP was focused on selling to Filipinos, initially targeting share sales to small savers,or ordinary salaried employees. To reach this segment, MFMCP planned to pitch to individualmembers of large pension funds and build a network of money centers.

7. MFMCP also planned to sell through 12 branches of PNB and 8 branches of theDevelopment Bank of the Philippines, and to open a network of its own branches, or moneycenters, throughout the country. In the long run, however, other large banks and a network ofMFCP agents were expected to drive share sales.

8. The minimum investment required to open an MFCP account was set at P5,000(equivalent to about $192 at the time of ADBs investment), with subsequent share purchases

available in P1,000 denominations. MFCP was also planning seminars and other outreachefforts to educate the public on the funds potential benefits and attract new investors.

9. Combining sales to individuals and institutional investors, MFCP was targeting a fundsize of P1.2 billion. To prevent a large drop in net assets, ADB and the founding shareholdersagreed not to divest their shares for two years.

C. Progress Highlights

10. About a year after MFCPs launch, Philippine markets were struck by a series ofeconomic, political, and global shocks, the effects of which would not abate for 6 years. TheAsian financial crisis first caused a severe economic contraction in 19971998. After a brief

rebound, Philippine markets were hit again by high levels of political instability (including apresidential impeachment), serious revelations of stock-market fraud, growing macroeconomicimbalances, a huge devaluation of the peso, and global eventsincluding the bursting of thetech-stock bubble in 2000 and the 9/11 terrorist attacks in the United States in 2001.

11. While these conditions affected market performance broadly, MFCPs resultsa netfinancial internal rate of return (FIRR) of 6.1% through late 2003were generally morenegative than those of other balanced funds or the benchmark index. MFCPs net assets erodedto less than half the initial value due to investment losses, large redemptions by institutionalinvestors (themselves under financial stress), and disappointing share sales. The fund manager,MFMCP, saw its capital fall below statutory requirements and was forced, in August 2003, tosell a controlling stake in MFMCP to ATR KimEng Asset Management, Inc. (ATRKE), part of a

family of global financial services companies in Asia.

12. ATRKE has since improved fund performance, returning a net FIRR of 13.5% since thetakeover and establishing a 10-year track record that is competitive with its peers. Sinceinception, however, the fund has achieved a net FIRR of 3.5%. The fund is also very small interms of its net assets and shareholder base relative to several competitors that entered themarket after MFCP.


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13. Despite disappointing net asset growth, MFCP has assisted the expansion of mutualfunds by participating in industry efforts to lobby the government for key regulatory reforms. Twoof the major hurdles to the growth of mutual funds identified in the report and recommendationof the President (RRP)rules that effectively double-taxed capital gains on mutual funds andprevented fund managers from managing more than one fundwere eliminated in 1998. Sincethen, net mutual fund assets have grown by more than 30% per year (Appendix 1). Since 1996,

gross national savings have also increased, from about 18% to 40% (Appendix4).

14. While ADBs investment was not necessarily a causal factor in achieving the growth ofmutual funds or of the national savings rate, its continued presence in the market brought adegree of stability to the mutual funds industry at a very fragile time, and enabled the entranceof ATRKE into the market. ATRKE has since earned competitive returns, set high standards formutual fund operations, and been a leader in the industrys efforts to hold companies listed onthe Philippine Stock Exchange (PSE) to higher governance standards.

15. Anticipating its eventual divestiture, ADB resigned its board seat in 2006 but continues toparticipate as an active board observer. As of 31 December 2010, ADBs investment in MFCPwas worth P168 million (equivalent to $3.83 million) and the FIRR was0.04% in current dollars.

II. EVALUATION

A. Overview

16. The project is evaluated using the criteria defined in ADB's guidelines.4 The projectrationale and objectives segment below outlines the objectives envisaged during the approval ofthe project. The investment is appraised according to (i) development impact and outcomes,(ii) ADB investment profitability, (iii) ADB work quality, and (iv) ADB additionality. An overallevaluation of the project performance is then presented.

B. Project Rationale and Objectives

17. The main objective of ADB's investment in MFCP was to revitalize the Philippine mutualfund industry via a catalytic demonstration effect, with the overarching goal of mobilizingindividual savings to help finance corporate investment and propel economic growth. ADBanticipated that its investment would achieve this objective by lending credibility to andenhancing public confidence in the industry, and that the success of MFCP would in turn spurthe launching of other funds. The operation was also expected to foster the development of thesecondary market for securities and fixed-income instruments by creating greater demand forsuch securities.

18. The RRP also anticipated that the fund would target small savers and show a broadsegment of the population that a professionally managed and diversified mutual fund can offer

superior returns to saving deposits. Achieving project objectives therefore depended on the fundachieving good returns relative to the market. As for the RRP's emphasis on targeting smallsavers, there is no explicit definition of a small saver.

4ADB. 2007. Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations. Manila.


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C. Development Outcomes and Impact

1. Overview

19. The overall development outcome and impact is rated partly satisfactory based oncomponent ratings of partly satisfactory in private sector development; unsatisfactory in

business success; unsatisfactory for contribution to economic development; and satisfactory forenvironmental, social, health, and safety performance.

2. Private Sector Development

20. The private sector development is appraised under two categories: beyond companyimpacts and direct company impacts. The private sector impacts of the project have been onlypartly satisfactory. Further details on private sector development indicators and ratings are inAppendix 2.

a. Beyond Company Impacts

21. The project's beyond-company impacts are discussed under the stated objectives ofcontributions to mutual fund industry development and contributions to capital marketsdevelopment in the Philippines.

i. Contributions to Mutual Fund Industry Development

(i) Size of Mutual Fund Industry

22. In 1996, MFCP was one of only seven mutual funds in the Philippines. When the Asianfinancial crisis struck the country, MFCP contributed to the stability of the mutual fund industryby staying in the market. The net assets of all mutual funds fell by 46% in dollar terms in 1997.

At the end of that year, MFCPs net assets accounted for 23% of the industrys total.

23. MFCP saw its share of the mutual fund industry's total net assets decline to 0.5% by theend of 2010. While MFCPs net assets have declined since 1996, the net assets of all mutualfunds in the Philippines increased by a factor of nearly 40 (Appendix 1, Figure A1.1). Thegrowth began in 1998 with the enactment of the Comprehensive Tax Reform Program (CTRP).In 2000, the pace of industry growth quickened even more after the Central Bank of thePhilippines (BSP) issued a ruling that enabled mutual fund management companies to managemore than one fund.5 ATRKE has been able, therefore, to open four additional mutual funds inthe Philippines, with a combined P1.3 billion in assets under management (versus an industrytotal of P95.7 billion).

24. Yet the mutual fund industry in the Philippines remains small relative to many countries

in the region and has lagged its economic peer group (Appendix 1, Figures A1.2 and A1.3).While MFCP may have provided a measure of stability early on and enabled ATRKE to expandinto new funds, its impact on the overall growth of the mutual fund industry has been minimal.The catalytic and demonstration effects of the fund were limited due to its poor performance but,as discussed above, the real constraint on industry growth was the lack of a transparent andequitable tax and regulatory system.

5Because investors have different goals and risk appetites, management companies that offer various types of funds(e.g., balanced, stock, bond, and money market funds) can attract more investment and leverage their personneland infrastructure to achieve greater economies of scale.


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(ii) Outreach to Retail Investors

25. The mutual fund industry principally needs educated investors and the infrastructure toreach them efficiently. Personal investment is still a new concept in the Philippines andconsumers know little about the safety, liquidity, and potential returns of different investment

options. The lack of financial understanding prevents widespread consumer uptake and thuslimits the growth of mutual funds in the Philippines.

26. The number of mutual fund accounts is a good proxy for the number of investors. In thePhilippines, the number of accounts has grown from approximately 2,800 in 1998 to 106,000 in2010.6 While growth has been steep, the country was starting from a tiny investor base and thenumber of mutual fund accounts in the Philippines remains very small as a proportion of thepopulation (one-tenth of 1%).

27. MFCPs contribution to the growth of accounts was minimal, and it had little impact onthe participation of small investors in the mutual fund market. The fund accounted for 27% of allmutual fund investment accounts in 1998, but MFMCP (the original fund manager) was unable

to attract and retain more than 1,000 investors by the end of 2003. By that same time, theindustry had grown to more than 50,000 accounts. ATRKE has since increased the number ofMFCP accounts to nearly 2400 in 2010, but this is still a very small number and amounts to only2% of total mutual fund accounts. Under ATRKEs management, MFCP is trying to increase itsnumber of retail investors through direct selling, seminars, the internet, schools, and othereducational efforts.

(iii) Impact on Regulation and Policy

28. In the first 18 months after its inception, MFCP joined forces with other members of theInvestment Company Association of the Philippines (ICAP) to persuade the government to passthe CTRP, which was enacted in 1998. The CTRP eliminated double taxation of mutual fund

profits and thus opened the door to a period of sustained industry growth. ICAP also played animportant role in securing the right for fund managers to manage a family of mutual funds, ratherthan just a single fund, making mutual fund management a much more viable business. MFCPthus partly contributed to achieving critical reforms of mutual fund regulation and taxation.

29. The market for mutual funds in the Philippines remains stunted, however, becauseserious deficiencies in the regulatory framework have not been rectified. The regulatory andtaxation rules that apply to similar longer-term investmentsincluding mutual funds, unitinvestment trust funds (UITFs), insurance products, or pre-need products such as instrumentsto invest for a childs college educationvary for each product (see Appendix 1). Companiesand customers have to disentangle a complex web of different advantages and disadvantagesto decide which one of a set of very similar products to offer or purchase.

30. For more than 15 years members of the industry have been working with thegovernment to develop harmonized regulations for mutualized investment products. Their mostrecent efforts are manifest in the proposed collective investment scheme (CIS) law. Despitelongstanding acknowledgement that reforms are needed to enable fair competition, thedevelopment of the Philippine mutual fund industry is still constrained by the lack of an equitableregulatory environment.

6Data provided by the Investment Company Association of the Philippines.


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ii. Contributions to Capital Markets Development

(i) Stock Market Development

31. The increase in mutual funds and domestic savings in the Philippines has not translatedinto greater stock-market volume or depth. Although it has been very volatile, the PSEs market

capitalization as a percentage of GDP has trended downward over the past 15 years, reachinga peak of 97% in 1996 and falling to a low of 31% in 2008 (Appendix 4, Figure A4.3). In contrast,the size of the stock market relative to economic output trended upward in East Asia and thePacific region, and for lower-middle-income countries worldwide (Figure A5.3). At the end of2009, the stock-market capitalizations of these peer groups relative to GDP were more than30 percentage points higher than in the Philippines.

32. The number of companies listed on the PSE has grown very little since ADB invested inMFCP, from about 210 to 250 companies, making it one of the smallest listings on any market inAsia (Figure A4.4). Thus the growth in the mutual fund industry does not seem to have had anappreciable impact on the development of the stock market in the Philippines.

33. Also, while investors have little choice of companies to include in their portfolios, theyare further limited by the liquidity of the stocks issued. The volume of shares traded as apercentage of total shares listed on the PSE was slightly lower in 2009 than in 1995, and ismarkedly lower than in other Asian economies and in lower-middle-income countries worldwide(Figure A5.5).

34. Issues of corporate governance and ownership concentration are often cited among thelikely explanations of why the Philippine stock market has remained so underdeveloped.

(ii) Bond Market Development

35. Figure A4.6 in Appendix 4 shows end-of-year data for the amount of corporate and

government bonds outstanding as a portion of GDP in the Philippines and nine other Asiancountries from 2000 to 2010.7 The size of other Asian bond markets relative to domestic outputvaries greatly from 8% in India and 12% in Viet Nam8, to 51% in the People's Republic ofChina, 67% in Thailand, 96% in Malaysia, and 190% in Japan.

36. The Philippines remains on the lagging end of this spectrum, but its bond market hasgrown by about 25% per year since 2000. Only 12% of this debt is corporate rather thangovernment issued (Figure A5.7), compared with 9% in Viet Nam, 20% in Thailand, and 45% inMalaysia. Corporate issues in the Philippines have increased since 2005, when the PhilippineDealing and Exchange Corporation (PDEX) opened as a secondary market for government andprivate debt securities.

7Government bonds include obligations of the central government, local governments, the central bank, and state-owned entities. Corporate bonds comprise issues by both public and private companies, including financialinstitutions and international organizations.

8The relative immaturity of the Indian bond market is largely explained by its deficiencies with respect to disclosure

policies, bankruptcy processes, consolidation of government benchmark issues, and regulatory st ructures, as pera paper published by ADB: S. Wells and L. Schou-Zibell. 2008: Indias Bond MarketDevelopments andChallenges Ahead. Manila. Viet Nams corporate bond market was non-existent until 5 years ago, and the volumeof tradable government debt remains very small.


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37. So, while it remains relatively small compared with some Asian economies, thePhilippine bond market has grown steadily since 2000 and prospects for further deepening ofcorporate issues are good. Thus the growth in balanced mutual funds such as MFCP will likelyfurther contribute to the growth of the bond market.

38. However, mutual fund companies report that more transparency is needed regarding the

companies that issue bonds, for analysts to be able to properly rate and recommend theirprivate debt offerings. A more active government market with longer maturities on which to pricecorporate issues will contribute to the development of the bond market.

(iii) Growth of Domestic Savings

39. The RRP for ADBs investment in MFCP points to an average ratio of gross domesticsavings to GDP of 18.6% during 19911994. The RRP notes that a well-ordered and efficientmutual fund industry will enhance the scope and diversity of investment management productsand services, promote a higher level of domestic savings, and draw capital from areas of theeconomy with excess liquidity to those with inadequate capital.

40. Gross domestic savings in the Philippines have expanded significantly since ADBsinvestment in MFCP, more than doubling to 40% in 2009 (Appendix 4, Figure A4.2). The extentto which increased savings have been invested in domestic capital markets is unclear. Mutualfund net assets amounted to only 2.4% of national savings in 2009, so only a small portion ofthe increase in savings has been invested in mutual funds. Due to its poor performance and itslack of substantial investor outreach, MFCP has had minimal impact on any increase in savingsdeployment in mutual fund assets.

b. Direct Company Impacts

41. ATRKE has introduced robust analytical practices and investment policies. For instance,it is one of just a few mutual fund management companies in the Philippines using Bloombergs

Asset and Investment Manager system. This platform integrates with Bloombergs data productsto provide ATRKE with a rich source of constantly updated information and the tools to takeadvantage of it quicklytools for executing trades, tracking and analyzing portfolio positions,and managing risk and compliance.9

42. ATRKEs rigorous approach to investment screening and its use of Bloomberg's Assetand Investment Manager system sets it apart from most of its competitors. Employees who trainin the use of these tools become assets for other mutual fund management companies, giventheir valuable knowledge and practical skills from their employment at ATRKE.

43. MFCP is credited with having developed a fully documented operations manual at itsoutset that was used by the SEC to assist other companies in the process of setting up mutual

funds. MFCP reportedly also led the industry by publishing its results based on longer-termreturns rather than just daily returns, and by adherence to a code of ethics.

44. More recently, ATRKEs managing director has become president of the Fund ManagersAssociation of the Philippines (FMAP), an industry organization that includes trusts andinsurance companies as well as mutual funds. Under ATRKEs leadership, FMAP is makingefforts to improve corporate governance among investee companies. Thus, MFCP has made

9Available: http://www.bloomberg.com/solutions/bloomberg_enterprise/trading_solutions/


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valuable contributions to promoting corporate governance and improving reporting standards inthe mutual fund industry.

3. Business Success

a. Market Context

45. MFCP has been affected by dramatically different economic, political, and global events,which map to the two periods in which the fund was managed first by the MFMCP then byATRKE. 10 During the difficult investment climate that prevailed from 19972002, the fund wasmanaged by MFMCP. When the Asian financial crisis hit the Philippine economy in 1997, MFCPproduced negative returns for the year, as did market benchmarks and most balanced funds(Figure 1).

Figure 1: Annual Returns MFCP, Blended Index and Phisix

MFCP = Mutual Fund Company of the Philippines.Sources: Philippine Stock Exchange fact books and annual reports; Bureau of Treasury; BangkoSentral ng Pilipinas, Private Sector Operations Department records, ATR KimEng Asset Management,Inc..

b. MFMCP Performance

46. From 19962003, MFCPs generally negative results compared with the market were, inlarge part, the product of poor investment decisions. Until the third quarter of 1998, the chiefinvestment officer at Clemente Capital headquarters in New York made all investment decisions,which MFMCP personnel in Manila would execute. Given the volatile market conditions and thedifference in time zones, making investment decisions was difficult.

10 See Appendix 3 for more details on the funds history and performance.

-60.0%

-40.0%

-20.0%

0.0%

20.0%

40.0%

60.0%

80.0%

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

MFCP Blended index Phisix


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9

47. Clemente Capital eventually authorized the Manila-based president of MFMCP to makeinvestment decisions on a day-to-day basis, and adjusted its investment strategy. However, bythe time these changes were made, the accumulation of investment losses had contributed tothe erosion of MFCPs capital base. The fund had P560 million in net assets at the end of 1996;by the end of 1998, it had little more than half that amount (Figure 2).

48. The decline in MFCPs net assets was also due to the complete divestiture, in 1998, of

two founding shareholders: the retirement funds of the San Miguel Corporation and the ArmedForces of the Philippines. They withdrew from MFCP because they themselves came underfinancial strain from the Asian financial crisis. Together, these institutions held about 40% ofMFCPs subscribed shares.

49. While MFCP improved its performance in 1999, the relatively positive results did notcontinue. MFMCP realized in 2000 that the Philippine markets were facing a bleak outlook dueto serious macroeconomic and governance problems. International investment advisors like INGBaring had rated Philippine stock markets as underweightmeaning that investors should sellrather than buy Philippine equities. In August of 2000, MFMCP sought the support of MFCPsboard of directors to change the funds investment policy that restricted investment in securitiesoutside of the Philippines. ADBs board representative expressed concern that such a change

would run counter to the funds objective of stimulating development in the Philippines. Thequestion was tabled and apparently never reconsidered. While the ability to better diversifymight have helped the fund, MFCP underperformed the countrys blended index in 20002002.

Figure 2: MFCP Net Assets(P million)

MFCP = Mutual Fund Company of the Philippines.Source: Investment Company Association of the Philippines.

-

100

200

300

400

500

600

700

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010


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10

50. In part due to its investment performance, MFCP had disappointing net sales after themajor sell-off in 1998, through to 2003. Figure 3 shows the amount of MFCP shares sold in anygiven year, minus the amount redeemed, which equals net sales.11

Figure 3: MFCP Net Sales

(P million)

MFCP = Mutual Fund Company of the Philippines.Sources: Investment Company Association of the Philippines, Private Sector Operations

Department records, ATR KimEng Asset Management, Inc.

51. MFCP sales suffered particularly from a lack of effective distribution channels. Bankswere not committed to providing referrals, as they offered competing products (Appendix 1), andregulations prohibited them from selling mutual funds directly to their customers and receiving a

commission on these sales. At the same time, MFCP was unsuccessful in selling to members ofpension funds, and had to close two of three retail money centers it had opened due to poorsales and high overhead costs.

52. The decline in MFCPs net assets caused by low sales, high redemptions, and poorinvestment performance forced MFMCP to gradually shed key professional staff, as itsmanagement fee income had declined along with the funds capital base. This downsizingfurther affected fund performance. By the end of 2002, MFCPs net asset value per share hadslid to P0.48, net income amounted to a loss of P51.2 million, and net assets had fallen toP226 million.

53. By 2003, there was only one person managing MFCPs portfolio, and only about 9 staff

were allocated to research, sales and marketing, reporting and administration, including back-office functions. MFMCPs capital had fallen below the required minimum for a fundmanagement company, and its shareholders were not willing or able to invest more. MFMCPsperformance was unsatisfactory.

11In 1997, for example, MFCP sold about P105 million in shares, but redeemed P8 million, thus the net sales amountshown in the figure is P97 million.

(250.0)

(200.0)

(150.0)

(100.0)

(50.0)

-

50.0

100.0

150.0

1997 1999 2001 2003 2005 2007 2009


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11

c. ATRKE Performance

54. In August of 2003, ATRKE infused P10.3 million into MFMCP to gain 70% ownership ofthe company. It would ultimately increase its stake to 95% and change MFMCPs name to ATRKimEng Asset Management, Inc., a subsidiary of ATR KimEng Financial Corporation. ATRKEhas been successful in improving the funds investment performance. In the past 7 years, MFCP

has produced a net FIRR of 14.3% (Table 1), which ranks it third out of four funds that havebeen in operation that long.

55. ATRKE did not decrease the funds equity exposure fast enough to stave off high losseswhen markets declined as a result of the global financial crisis. Then, it did not reinvest in stockssoon enough to reap the most benefit from the recovery. ATRKE also maintains that itsperformance is not strictly comparable to that of other balanced funds, as these competitorssometimes maintain an equity exposure that is proportionally much higher or lower thaninvestments in fixed income and other securitiesdisqualifying the fund as balanced.

56. From the retail perspective, MFCP has fared better under ATRKE, as the number ofaccounts increased (Appendix 3, Table A3.4), mostly through direct selling, seminars, and

internet outreach. The portion of MFCP assets held by individuals relative to institutions hasalso increased, as has the total value of assets held in smaller-sized accounts.

57. ATRKE is also focused on keeping institutional investors satisfied. However, MFCP hasrecently suffered from high redemptions. In 3 of the past 4 years, redemptions have exceededsales. In 2010, net redemptions were the highest in MFCPs history, at P193 million.

58. ATRKE is very optimistic about the fund's near-term sales and investment prospects. Itsforemost concern is the interest rate environment, as investors have little incentive to take ongreater risk when government securities generate relatively high earnings. ATRKEsperformance has been partly satisfactory.

d. Fund Performance

59. Over the past 10 years, MFCPs annualized return has been in line with other balancedmutual funds in the Philippines (Table 1).12 In the first 7 years of its operation, however, thefunds returns were poor relative to its peers, which brings its net FIRR since inception down to3.47%, compared with 9.6% for the only competitor also operating since 1996, and 5.62% forthe blended index.

12Throughout the funds history, its fund managers have maintained that many of its competitors are not trulybalanced funds, because at times their portfolios are composed largely of equities or bonds.


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12

Table 1: Annualized Returns: Blended Index, MFCP, and Peers

1Year

3 Year 5Year

7Year

10Year

Since1996

MFMCPPeriod

ATRKEPeriod

Blended Index 23.8% 5.9% 8.6% 9.6% 8.3% 5.6%MFCP Kabuhayan

Fund

42.3% 8.6% 14.4% 14.3% 10.8% 3.5% (6.1%) 13.5%

Philam Fund 48.7% 10.9% 17.3% 17.0% 14.5% 9.6%GSIS KinabukasanFund

47.3% 11.3% 19.2% 18.1% 10.6%

Sun Life ProsperityBalanced Fund

30.7% 5.9% 12.5% 13.0% 10.3%

First Metro Save &Learn Balanced Fund

62.0% 20.0% 26.9%

ATRKE =ATR KimEng Asset Management, Inc., MFCP = Mutual Fund Company of the Philippines.Source: Private Sector Operations Department records, Investment Company Association of the Philippines, Bureau ofTreasury, Bangko Sentral ng Pilipinas.

60. As Table 1 indicates, MFCP's performance varies greatly before and after ATRKE tookcontrol of the fund management company. The net FIRR for the period before ATRKEs controlis6.1%, compared with positive 13.5% thereafter.

61. Reflecting the generally positive economic trends, MFCP has averaged 17% growtheach year from 2004 to 2010, earning negative returns only in 2008 (Figure 4). As per theGuidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations(footnote 4) the business success of MFCP has been measured by computing the return oninvested capital (ROIC), which is used as a proxy for the FIRR. The real ROICis2.27% and thenominal ROIC is 3.22%. As MFCPs ROIC is more than 200 basis points lower than thecompound annual growth rate of the blended index (5.62%, as per Table 1), the businesssuccess of ADBs investment in MFCP is unsatisfactory.13

62. Figure 4 indicates the performance of MFCPs net assets per share over time.

13As the compound annual growth rate for the blended index is in nominal terms, MFCPs nominal ROIC is used toassess business success.


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13

Figure 4: Net Asset Value Per Share

Source: Investment Company Association of the Philippines.

4. Economic Sustainability

63. The economic rate of return on ADB's investment in MFCP is calculated as per ADBguidelines (footnote 4). Accordingly, the economic return on invested capital (EROIC) is used asa proxy for the economic internal rate of return (EIRR) because equity funding for this projectwas not targeted at specific capital investment projects.

64. EROIC is calculated by using the financial rate of return on MFCPs capital and adjustingfor fees and taxes paid. The real EROIC for the ADB equity investment in MFCP computes to avalue of 0.26%. According to ADB guidelines, an EROIC lower than or equal to 5% isunsatisfactory, thus the contribution to economic development of the project is ratedunsatisfactory.

65. However, there are additional economic benefits to ADBs investment in MFCP thatcannot be precisely measured or directly attributed to the investment. These benefits include thevalue created in output and employment by the dozens of companies in which MFCP hasinvested over the past 15 years. Given that ADBs participation may have prevented thedissolution of MFCP and enabled ATRKEs takeover of the fund management, the investmentalso played a part in the development of ATRKEs additional mutual funds, which haveP1.3 billion invested mostly in Philippine stocks and bonds.

66. At the same time, both MFCP fund managers have actively pursued efforts to improvethe regulatory framework for mutualized investments and the standards that apply both to themutual fund industry and to listed companies in the Philippines. Since there were so few fundsactive in the late 1990s, it is possible that MFCPs voice helped tip the scales in favor ofimportant changesincluding the enactment of the CTRP and BSPs decision to allow mutualfund managers to oversee more than one fundand that ADBs backing lent credibility to thoseefforts. These effects cannot be meaningfully measured, but they are certainly positive, and thelong and steep growth path of the mutual fund industry attests to their sustainability.

1.04

0.750.67

0.79

0.60

0.550.48

0.660.75

0.86

1.181.31

0.93

1.14

1.63

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010


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14

5. Environmental, Social, Health, and Safety Performance

67. The subscription agreement signed between ADB and MFCP on 15 April 1996 requiresthe fund manager to review an investees level of compliance with environmental laws,regulations, and standardsincluding those relating to environmental impact assessments andinvoluntary resettlementbefore it purchases any security for the first time or when making

subsequent purchases. The MFCP investment did not have any additional socially orientedobjectives other than attracting the country's mostly small-scale savers.

68. MFMCP and ATRKE have complied with the requirement to review an investeescompliance with environmental laws, regulations, and standards by periodically obtaining a listof environmental clearance certificates (ECCs) provided by the Environmental ManagementBureau, and making sure that an ECC has not been denied to any company in which the fundhas an equity position.

69. This approach, combined with normal due diligence practices, has proved a satisfactorymeans of fulfilling ADBs environmental standards as they existed at the time the investmentwas made, thus the MFCP investment is rated satisfactory regarding environmental, social,

health, and safety performance. The cost and benefits of undertaking a detailed, in-depth reviewof an investees performance in these matters every time a security is purchased would notprove worth the effort, as individual mutual funds have no say in an investees governance, andno means to recover the additional costs of such reviews and stay competitive in their feestructures.

D. ADB Investment Profitability

70. In April 1996, when ADB approved the purchase of 100,000,000 shares in MFCP, thenet asset value per share was P1.00, so the value of ADBs investment was P100 million(equivalent to $3.85 million at the time). As of 31 December 2010, MFCPs net asset value pershare had increased to 1.6276, and ADBs number of shares had grown to 103,186,867, as

dividends issued by MFCP in 2009 were converted into additional shares. The value of ADBsinvestment, therefore, was P168 million ($3.83 million equivalent), which generates an FIRR of

2.13% in real pesos and0.04% in dollars.

71. These returns compare with an expected net FIRR of 23% in dollar terms in the RRP.According to ADB's guidelines (footnote 14), because MFCPs net FIRR is less than 0.7 timesthe expected rate of return established at approval, the project is rated unsatisfactory regardingADB investment profitability.

72. However, compared with a composite index of equities on the PSE, which earned a netFIRR (in current pesos) of 3.26% in 19962010 (Appendix 3, Table A3.3), ADBs investment inMFCP earned almost 50 basis points more, with a net FIRR in current pesos of 3.77%.

E. ADB Work Quality

73. ADB's work quality is rated satisfactory. Though the rationale for the project and its initialdesign suffered from overly optimistic assumptions, the operation was a rather unique attempton the part of ADB to intervene proactively in a severely underdeveloped and key part of thefinancial system. ADB staff took an active and watchful interest in the project over the greaterpart of its long life, and the investment has produced some important results and lessons, aswell as other benefits (para. 65).


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15

a. Screening Appraisal and Structuring

74. The rationale for the investment is based on the idea that the mutual fund industry wouldbenefit from the injection of capital from a highly credible institutional investor like ADB. Whilethe RRP emphasizes that serious tax and regulatory disadvantages were restricting industrydevelopment, it does not attempt to weigh the effects of these problems against the perceived

need for catalytic effects. The tax and regulatory disadvantages were determining factors fornew entrants into the mutual fund market.

75. The projects RRP places emphasis on the fund's expected benefits to small savers, butnever explains how it defines these beneficiaries, nor does it set any targets against which tomeasure the investment's success.

76. Regarding the initial design, the RRP also overestimates the potential returns of theinvestment. While the RRP notes important performance risksincluding poor performance ofinvestee companies brought on by an unfavorable regulatory environment or political andeconomic turbulence, as well as the risk of currency fluctuations that could negatively affect thevalue of peso-denominated assetsthere is no robust analysis of these risks. In the case of

currency depreciation, for example, the RRP simply cites improving economic conditions andrecent exchange rate stability as reasons to judge the level of risk as acceptable. Though it maynot have changed the decision to invest in MFCP, an analysis of the funds performance underbest, worst, and base-case economic scenarios would have provided a better basis for riskassessment. Thus, screening, appraisal, and structuring are rated partly satisfactory.

b. Monitoring and Supervision

77. After the investment had been made, ADB was very engaged in oversightattendingboard meetings and keeping close track of the fund and the fund manager. Project recordsshow frequent communication between the fund and ADB staff. However, as the investmentaged, ADB may have lost some rigor with respect to fund governance. Board meeting

participation and other means of fund supervision become less traceable in the project filesaround 20012002. Monitoring and supervision is rated satisfactory.

c. ADB Role and Contribution

78. In 2003, however, ADB participation in board meetings was crucial for convening aquorum to approve ATRKEs takeover of the fund manager, and then to authorize importantchanges to fund policy and practice.

79. ADBs long investment in MFCP has contributed to the funds survival, and prevented amore serious industry free-fall in 1997. ADB also reportedly encouraged MFCP to develop thecomprehensive operations manual that was used by the SEC to assist other companies in the

process of setting up mutual funds; to fully disclose risks to potential investors in the prospectus;and to adopt a code of ethics. ADB's role and contribution are thus rated satisfactory.

d. Overall ADB Work Quality

80. As discussed above, screening, appraisal, and structuring of this operation are ratedpartly satisfactory; monitoring and supervision are rated satisfactory; and ADB's role andcontribution are rated satisfactory. Overall work quality is rated satisfactory.


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16

F. ADB Additionality

81. ADBs investment played an important role in getting MFCP off the ground in 1996,though it is impossible to know what would have happened otherwise. Six other institutionalinvestors had committed capital before ADB signed its subscription agreement (Table 2).

Table 2: Institutional Investors and Ownership Shares at Fund Inception

Shareholder % Ownership April 1996

ADB 18.9%Armed Forces of the Philippines Retirement andSeparation Benefits System

18.9%

Pag-Ibig (Home Development Mutual Fund) 18.9%Philippine Long Distance Telephone Co. BeneficialTrust

18.9%

San Miguel Corporation Retirement Fund 18.9%Meralco Pension Fund 3.8%

PNB Provident Fund 1.9%ADB = Asian Development Bank, PNB = Philippine National Bank.Source: Private Sector Operations Department records.

82. ADB was one of the largest and most respected of MFCPs founding shareholders, andits participation may have been key, in early 1997, to attracting other international investors.When ATRKE took over the fund management, it took advantage of its parent companyspresence in Hong Kong to target overseas workers from the Philippines as well as localinstitutions. Having ADB as a shareholder in the fund was meaningful to these investors, whogenerally recognized and trusted the name. ADB is therefore likely to have contributed at these

junctures. Overall, however, MFCP has not been able to leverage ADBs participation to grow itsnet assets (Figure 2). The banks ownership has hovered around 20%22% since 1998, and

jumped up to nearly 34% at the end of 2010 due to large fund redemptions (Table 3). ADBs

additionality is rated satisfactory.

Table 3: Value of ADB Shares in the Fund as a Percentage of Net Assets

End of Year

1996 2000 2003 2010ADB's Ownership Percentagein MFCP 18.3% 21.8% 21.4% 33.6%ADB = Asian Development Bank, MFCP = Mutual Fund Company of the Philippines

Source: Private Sector Operations Department records, ATR KimEng Asset Management, Inc.

G. Overall Evaluation

Table 4: Performance of the Investment in the Fund

Unsatisfactory Partlysatisfactory

Satisfactory Excellent

Development Impact XPrivate sector

developmentX

Business success X


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17

Unsatisfactory Partlysatisfactory

Satisfactory Excellent

Contribution toeconomic

development

X

Environmental, social,

health,and safety performance

X

ADB InvestmentProfitability

X

ADB Work Quality XScreening, appraisal,

andstructuring

X

Monitoring andsupervision

X

ADB role andcontribution

X

ADB Additionality X

UnsuccessfulPartly

successfulSuccessful

Highlysuccessful

Overall Assessment XSource: Independent Evaluation Mission.

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS

A. Issues and Lessons

83. ADBs investment in MFCP was intended to catalyze the mutual fund industry in thePhilippines, but industry growth proved to be constrained by tax and regulatory rules that putmutual funds at a disadvantage versus other mutualized products. This became evident whendouble taxation was eliminated in 2000 and the industry began to take off, and when unitinvestment trust funds (UITFs) were forced to adopt marked-to-market valuation in 2004 andbegan to lose substantial ground to mutual funds (Appendix 1). While there may be caseswhere demonstration effects and increased market confidence stemming from an ADBinvestment could help foster market development, the bank must have stronger reasons andanalytical support for such an approach.

84. In some cases, leading a policy dialogue or financing technical assistance to support thedevelopment of a better enabling environment or build regulatory capacity, for instance, may bemore effective alternatives to an equity investment. In July of 1995, for example, ADB hosted aseminar on mutual fund industry regulation that is recognized now as the point of departure forthe modern mutual fund industrys growth and development. ADB also assisted the governmentin preparing a more appropriate Securities Regulation Code, enacted in 2001, and inreorganizing the SEC according to the new framework when the BW Resources scandal hit thePSE in 2000, exposing serious weaknesses in the SEC and its enabling legislation.14ADBs

14ADB. 1995. Technical Assistance to the Republic of the Philippines for the The Capital Market Development (TA2379). Manila. ADB. 2001. Report and Recommendation of the President to the Board of Directors: Proposed Loanto the Republic of the Philippines for the Nonbank Financial Governance Program (Loan 1858). Manila.


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18

credibility, expertise, and resources can thus be brought to bear on industry development indifferent ways.

85. Competition between UITFs and mutual funds still suffers from unequal regulatorytreatment. UITFs are contracts, regulated by BSP as banking products, whereas mutual fundsare overseen by the SEC and treated as corporations. They have very different costs and

benefits that are opaque and very difficult for offering companies and for investors todisentangle (Appendix 1). A lack of financial understanding is perceived as a key constraint tothe growth and widespread consumer uptake of mutual funds. Personal investment is still a newconcept in the Philippines and consumers know little about the safety, liquidity, and potentialreturns of different investment options.

86. Adding to the confusion, there are many other types of mutualized investment productsbesides mutual funds and UITFs, including variable unit-linked insurance products, pre-needproducts, and insurance annuity contracts, each with different regulatory and tax treatment. Formore than 15 years members of the industry have been working with government to developharmonized regulations for these products. The most recent efforts are manifest in the proposedCIS law, which incorporates and expands the reforms previously proposed in the Revised

Investment Company Act.

87. Regulatory harmonization is particularly critical now because, in 2008, Congress passedthe Personal Equity and Retirement Account Act, which allows Philippine citizens to createindividual retirement accounts and receive limited tax credits. The act has no implementing rulesyet, so there is only speculation about how it could affect incentives to sell or hold one type ofinvestment over the other. The law has the potential to greatly expand the universe of personalinvestors and the pool of investment capital, but also to add confusion to the market along withmore opportunities for regulatory arbitrage.

88. Under the best-case scenario, the CIS law would transfer regulatory responsibility for allmutualized investment products to the SEC, which is already seriously understaffed. For the

past 10 years, only one person has been dedicated to monitoring mutual funds, while net mutualfund assets have increased by a factor of nearly 40. If the SEC gains responsibility foroverseeing all mutualized investments, it will require a much larger program of support. There issubstantial need to build capacity and educate the SEC about international norms and bestpractices, and to provide support for organizational restructuring and staffing plans.

89. It is crucial for investors to have access to systems that allow them to easily administerregular cash payments to mutual funds from employer payrolls or bank accounts. Such accessis extremely limited in the Philippines, and in most cases face-to-face visits are needed tohandle payments or redemptions.

90. At present, the small number of listed companies on the PSE and the lack of liquidity in

their shares are not an important constraint on the growth of mutual funds, as there are stillrelatively few investors in the market. However, given the recent pace of mutual fund growth, itcould become an issue in the future.

B. Recommended Follow-up Actions

91. The following actions are recommended to follow up on the goals and achievements ofthe MFCP investment:


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19

(i) ADBs exit from MFCP should be gradual. ADB controls a large share of thefunds net assets (34%). Abrupt divestment would cause a precipitous drop in

ATRKEs fee income, which could hurt its ability to manage the fund. It could alsoalarm other investors and trigger a wave of fund redemptions.

(ii) Any future ADB policy analysis and dialogue on capital market development inthe Philippines could include issues relevant to the development of the mutual

fund industry.


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20 Appendix 1

MUTUAL FUND INDUSTRY DEVELOPMENTS

A. Market Size and Evolution

1. Mutual fund industry development in the Philippines has been characterized byspectacular growth over the past 15 years (Figure A1.1).

Figure A1.1: Mutual Fund Assets Under Management in the Philippines(P billion)

Source: Investment Company Association of the Philippines.

2. The number of mutual funds has increased from six in 1996 to approximately 45, andinvestor accounts have grown from approximately 2,800 in 1998 to 106,000 in 2010. In the1990s, the industry was starting from close to zero, and it remains small relative to manycountries in the region and to its economic peer group (Figures A1.2 and A1.3).

Figure A1.2: Net Mutual Fund Assets

(% of GDP)

Source: Investment Company Institute, Private Sector Operations Department records,mutual fund industry associations, regulators, and central banks.

-

20.0

40.0

60.0

80.0

100.0

120.0

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

0

0.1

0.2

0.3

0.4

0.5

0.6

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Philippines Korea Japan China India Pakistan


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Appendix 1 21

Figure A1.3: Net Mutual Fund Assets(% of stock-market capitalization)

Source: Investment Company Institute, Private Sector Operations Department records, mutual fundindustry associations, regulators, and central banks.

B. Competition and the Regulatory Framework

1. Mutual Funds and Unit Investment Trust Funds

3. Though there are other important factors, the key to realizing the industrys growthpotential lies in the development of an equitable regulatory environment for all mutualizedinvestment schemes. The lack of fair competition between similar products has stymiedPhilippine mutual fund industry development for decades, starting in the 1970s. At that time,banks invented a product called common trust fund (CTF) that was essentially a money marketfund invested mainly in fixed-income securities. CTFs were attractive because they carried noreserve requirements, and many banks used them as pseudo deposits. By 1993, when the

Central Bank of the Philippines (BSP) first instituted reserve requirements for CTFs (though at alower rate than deposits), assets invested in these instruments had grown to P112 billion 1compared with just P750 million in mutual funds.2

1ADB. 1996. Report and Recommendation of the President to the Board of Directors: Proposed Equity Investment inthe Mutual Fund Company of the Philippines. Manila.

2Investment Company Association of the Philippines.

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009Philippines Korea Japan China India Pakistan


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22 Appendix 1

4. BSP began a gradual phase-out of CTFs, replacing them with a very similar instrument,the unit investment trust fund (UITF). UITFs had reserve requirements on a par with deposits,but with two great advantages over mutual funds: (i) they did not face double taxation (mutualfunds had to pay corporate income tax and investors were also subject to taxes on their capitalgains); and (ii) UITFs were not valued on a marked-to-market basis.

5. In 1998, the Comprehensive Tax Reform Program (CTRP) eliminated the doubletaxation of mutual funds, and opened the door to a period of rapid growth. Still, the valuationmethod for UITFs made them much more advantageous than mutual funds and by 2004, CTFsand UITFs held about $620 billion in assets under management, whereas mutual funds heldonly $54 billion.3

6. When BSP issued a rule requiring UITFs to adopt marked-to-market valuation in 2004and finalized the phase-out of CTFs, competition between trusts and mutual funds became amore even contest, though it is still far from equitable. The main difference between these verysimilar offerings is that UITFs are contracts, regulated by BSP as banking products, whereasmutual funds are overseen by the Securities and Exchange Commission (SEC) of thePhilippines and treated as corporations.

7. Every mutual fund must have the minimum required seed capital and pay registrationfees to the regulator, and it reportedly takes a year to obtain a license. As corporations, eachmutual fund must cover the costs associated with having a board of directors, producing annualreports, and convening shareholder meetings. Mutual funds must also pay a documentarystamp tax on shares reissued after redemption. UITFs, on the other hand, require no pre-approval or seed capital, net assets are simply included when calculating the fee that banks payBSP for supervision, and they incur no stamp tax.

8. Mutual funds have some advantages over UITFs, however. For instance, they hold taxesat the corporate level, whereas many UITFs have a final 20% withholding tax at source. Theissuer of a bond pays that tax but passes it on to the UITF. A mutual fund also has to pay this

bond tax, but on its books the 20% is more than its expenses (i.e., it has negative income), thusno tax is withheld. Mutual funds can also have an incentive structure with a carry, and cancreate funds of funds and invest overseas. Nonetheless, UITFs have an important advantage inthe treatment of tax-exempt organizations, which are potentially the largest purchasers ofmutual funds.

9. These are only some of the regulatory and tax differences between mutual funds andUITFs, the result of which is that companies and customers have to disentangle the complexweb of advantages and disadvantages of very similar products before they decide what to offerand purchase. The outcome of this weighing of options, it turns out, depends on the economicenvironment. If interest rates are high, mutual funds are better for investors because not allmutual fund assets are valued at marked-to-market. If interest rates are low, UITFs are more

advantageous to investors.

2. Other Competing Products

10. Philippine investors looking to place their savings have other options besides mutualfunds and UITFs. In 2007, BSP introduced special deposit accounts (SDAs) issued for 30, 60,90, 120, and 180 days, and allowed banks to retail these products, which paid 3% more than T-

3

Mission interviews.


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Appendix 1 23

bills and carried no reserve requirements. As a risk-free alternative to mutual funds, SDAspresented a serious competitive threat before BSP limited them to 14-day and 30-day tenures in2008.

11. More similar to mutual funds are variable unit-linked insurance products, pre-needproducts, and insurance annuity contracts. The Insurance Commission regulates providers of

these products. Very little data is available on the amount invested in the variable unit-linked,pre-need, and annuity products, and industry observers voice concerns about the adequacy ofthe reserves that back these contracts.

12. Adding complexity to the market for mutualized investment products, in 2008 Congresspassed the Personal Equity and Retirement Account Act, which allows Philippine citizens tocreate individual retirement accounts and receive a 5% tax credit for contributions up toP100,000 for individuals and P200,000 for families. The act has no implementing rules yet, sothere is only speculation about how it could affect incentives to sell or hold one type ofinvestment over the other. The law has the potential to greatly expand the universe of personalinvestors and the pool of investment capital, but also to add confusion to the market along withmore opportunities for regulatory arbitrage.

C. Market Development Priorities

1. Harmonizing the Regulatory Treatment

13. For more than 15 years members of the industry have been working with government todevelop new regulations for mutualized investment products. The most recent efforts aremanifest in the proposed collective investment scheme (CIS) law, which incorporates andexpands the reforms previously proposed in the Revised Investment Company Act. The CIS lawaims to harmonize regulations for all forms of mutualized investments across the board.

14. A technical working group was formed in 2007 to promulgate the new law, and it

recommended that mutual funds, UITFs, variable unit-linked insurance, pre-need products, andinsurance annuity contracts be sold and regulated via a corporate structure in which investorsbuy shares, rather than simply sign contracts to purchase units. The SEC would regulate theseproducts and the companies offering them. While there is much consensus around the CISproposal, domestic banks are reportedly resisting the changes. BSP and the InsuranceCommission are also reticent about giving up regulatory control over the products they nowoversee.

2. Building Regulatory Capacity

15. There have been very few new rulings from the SEC on mutual funds in the past 5 years,as the regulator struggles to keep up with an industry that has grown by more than 25% in that

time. The SEC is too understaffed to manage the increased workloadfor the past 10 years,only one person has been dedicated to monitoring mutual funds. The SEC has said that it needshelp both in developing new regulations for mutual funds and in building its capacity to regulate.If the SEC gains responsibility for overseeing all mutualized investments, it will require a muchlarger program of support.


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D. Industry Prospects and Needs

16. The mutual fund industry in the Philippines is still at an early stage of development. Aslong as government debt is not generating equity-like returns, and no additional regulatorydistortions are put in place, mutual funds will be a competitive option for longer-term investors.The Personal Equity and Retirement Account Act could significantly accelerate the industry's

growth, if the act is regulated properly.

17. In addition to fair and sound regulations, the mutual fund industry principally needseducated investors and the infrastructure to reach them efficiently. Personal investment is still anew concept in the Philippines and consumers know little about the safety, liquidity, andpotential returns of different investment options. Many industry participants agree that a lack offinancial understanding seriously limits growth and consumer uptake of mutual funds.

18. At the same time, efficiently administering share sales requires systems that allowcustomers to easily set up regular cash payments from their employers or their bank accounts.Such ease does not exist in the Philippines, and in most cases face-to-face visits are needed tohandle payments. The infrastructure to electronically administer payments is crucial for mutual

funds, as they do not have the extensive branch or agent networks on which banks andinsurance companies rely for customer contact.

19. At present, the small number of listed companies on the Philippine Stock Exchange andthe lack of liquidity in their shares are not an important constraint on the growth of mutual funds,as there are still relatively few investors in the market (Appendix 4). Given the recent pace ofmutual fund growth, however, it will become a problem in the near future.


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Appendix 2 25

PRIVATE SECTOR DEVELOPMENT INDICATORS AND RATINGS

Indicators Ratings a Justifications/Annotations

1. Wider Sector and Economy ImpactBeyond

Intermediaries and Investees1.1 Private sector expansion andinstitutional impact:1.1.1 Contribution by the fund topioneering or materially increasing theprivate sector's share and role in theeconomy.

1.1.2 Institutional developmentcontribution by:

(i) improving supply of risk capital inthe market;

(ii) demonstrating the merits ofprivate mutual funds to the public,firms, banks, and others;

(iii) bringing liquidity to local stockexchanges;

(iv) helping a mutual fundindustry take root and becomemore efficient along with maturingcapital markets; and

(v) enabling wider mutual fundexpertise via migration of fundmanager staff to other funds, etc.

Partly satisfactory The mutual fund industry grewsharply since MFCP initiatedoperations, but the fundcontributed very little to thatgrowth, as its net assetsactually declined over the 19962010 period. However, ATRKEhas leveraged its infrastructureand know-how to open fouradditional mutual funds in thePhilippines, with a total of P1.3

billion in mutual fund assetsunder management (comparedwith an industry total of P95.7billion).

Likewise, the number of mutualfund accounts has grownsignificantly but MFCP has hadpoor retail performance and littleimpact on the increased numberof investors. MFCP had only2800 accounts in 2010, while

the industry has grown to morethan 106,000 accounts, which isstill a very small number giventhe population of the Philippines(estimated at more than 94million for 2010).

The capital markets have shownsome positive signs of growthsince MFCP began itsoperations, but little of theprogress, or lack of it, can be

attributed to the fund. Domesticsavings have increaseddramatically but those funds arenot largely invested in mutualfunds or directly in the stock andbond markets.

The market capitalization of thePhilippine Stock Exchange as a


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26 Appendix 2


share of gross domestic producthas trended downward in thepast 15 years, the number oflisted companies has grown

from about 210 to just 250, andthe volume of shares traded asa percentage of total shareslisted was slightly lower in 2009than in 1995.

The Philippine bond market hasgrown steadily since 2000.Prospects for continued growthare good, especially forcorporate issues, which haveincreased as a portion of total

bonds outstanding since thePhilippine Dealing andExchange Corporation wasopened as a secondary marketfor government and private debtsecurities in 2005.

1.2 Competition: Contributions torenewed competitive pressures in keyinvestee markets and/or in the financialsector for risk capital and finance.

Partly satisfactory Except for its early years, MFCPhas been a small, not verycompetitive player in the mutualfund market. For the past 10years, however, the fundsannualized returns have been

competitive with other balancedfunds.1.3 Innovation: Indications that the fundhelped introduce effective new products,services, and new technologies, as wellas replicable new business strategies ininvestee companies, or in the way thefund operates, thereby supporting reformand transformation of business sectors,industries and/or maturing financialmarkets (see 2.2 below).

Satisfactory ATRKEs managementinformation system(Bloombergs AIM) and robustinvestment analysis toolscreated a new standard againstwhich other funds compete.Employees who train in the useof these tools become assetsfor other mutual fundmanagement companies, given

the valuable knowledge andpractical skills from theiremployment at ATRKE.

1.4 Catalytic element: Pioneering orcatalytic finance that mobilized, or willcontribute to, wider and better debt orrisk capital supply from local and foreigninvestors to investees and to localfinancial sectors generally.

Partly satisfactory In 1996, MFCP was one of onlyseven mutual funds, with onlyone other fund entering themarket in 1997. MFCPs netassets accounted for nearlyone-quarter of the industry total


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Appendix 2 27


for both those years. Thus itwas a pioneer in the industryand, as a big fund at that time,MFCP contributed some degree

of stability to the industry duringthe Asian financial crisis. Thecatalytic or demonstrationeffects of the fund were limited,however, because industrygrowth was constrained by anunequal tax and regulatorytreatment, and because fundperformance was poor.

1.5 Affected laws, frameworks,regulation: Contribution to better legaland regulatory private sector

frameworks, or to better financial sectorregulation, e.g., by observed lobbyingactivity. The fund manager reports onsignificant dialogue affecting reform.

Partly Satisfactory MFCP fund managerssuccessfully joined forces withother members of the

Investment CompanyAssociation of the Philippines tofinally persuade government topass the Comprehensive TaxReform Program, whicheliminated the double taxationof mutual fund profits andopened the door to a period ofvery fast growth. They alsosecured the right for fundmanagers to manage more thanone mutual fund, which made

mutual fund management amuch more viable business.However, despite years ofefforts to harmonize regulation,huge obstacles to faircompetition remain, as verydifferent rules apply to similarmutual investment products.

1.6 Wider demonstration of newstandards: Complies with goodstandards, and has set replicable newstandards in, among others, corporate

governance; transparency; stakeholderrelations; environmental, social, health,and safety performance; and energyconservation. Demonstrated governancestandards and improved transparency.(See 2.2 below)

Satisfactory ATRKE incorporates theevaluation of an investeesenvironmental, social, andgovernance performance, which

is a unique practice in theindustry.

2. Investee-Level Impact

2.1 Skills with demonstration and Not Applicable As a mutual fund, MFCP could


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28 Appendix 2


wider dissemination potential:- Manifest achievements in new strategicand operational management skillscontributed to successful investee

enterprises with potential for morewidespread demonstration andreplication.- Achievements in developing skills inmutual fund management, instruments,and new ways to invest that the fundstaff can apply in follow-on funds, orwhen joining new mutual funds, banks orother financing.

not own more than 10% of theissues or any given investeecompany, and frequentlychanged its positions. MFCP

thus did not have a directoperational impact on thecompanies in which it invested.

2.2 Demonstration and new standard-setting potential:- As seen in new ways of operating

businesses and competing, and whereinvestee performance is comparable withrelevant best industry benchmarks andstandards- As evident in set standards in corporategovernance and stakeholder relations

Satisfactory MFCP is credited with havingdeveloped a fully documentedoperations manual at its outset

that was used by the Securitiesand Exchange Commission ofthe Philippines to assist othercompanies in setting up mutualfunds. Likewise, projectdocumentation indicates thatthe MFCPs prospectus wasexemplary for its full disclosureof relevant information toprospective investors. MFCPreportedly led the industry bypublishing its results in the

newspapers based on longer-term returns and not just dailyreturns, and by adherence to acode of ethics.

ATRKE is working with the FundManagers Association of thePhilippines to implementstronger corporate governancerequirements within investeecompanies.

Overall Private Sector Development

Rating

Partly satisfactory

ATRKE = ATR KimEng Asset Management, Inc.; MFCP = Mutual Fund Company of the Philippines.a

Ratings scale: Unsatisfactory, Partly Satisfactory, Satisfactory, and Excellent. The rating is not an arithmetic mean ofthe individual indicator ratings, and these have no fixed weights. It considers actual impact (positive or negative) andpotential further impact as well as risk to its realization.


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Appendix 3 29

REVIEW OF THE FUND

A. Fund Management and Governance

1. The Mutual Fund Company of the Philippines, commonly known as the

The Mutual Fund Company of the Philippines

Documents

Transcript of The Mutual Fund Company of the Philippines