Mutual funds enters second year of booming

Mutual funds enters second year of booming

Dadan Wijaksana, The Jakarta Post, Jakarta

The country's mutual fund industry has entered another year of
rapid growth. After its value soared to Rp 46 trillion (about
US$540 million) in 2002, the industry has today almost doubled to
Rp 90 trillion.

It's quite an achievement considering the money circulating in
the industry was still valued at Rp 8.5 trillion early last year.

The Capital Market Supervisory Agency (Bapepam) said that some
80 percent of the funds were invested in government
recapitalization bonds, 90 percent of which carry fixed-income
interest rates.

Traders and analysts have attributed the enormous growth in
the industry to the fact that, as an alternative investment
instrument, it offers better returns as compared to others.

For investors, the government bond-based mutual funds may be a
more attractive investment vehicle, than bank time deposits, the
interest rate of which has been steadily declining in line with
Bank Indonesia's persistent move to cut its benchmark rate.

Moreover, based on Tax Law No. 17/2000, interest gained by
mutual funds invested in bonds is not subject to income tax in
its first five years since it was floated.

This means that, while revenue from interest rates in time
deposits -- currently at around 12 percent to 13 percent -- is
subject to 20 percent tax, returns from the mutual funds of
around 13 percent to 14 percent per annum are tax free.

Although investing in the country's high-flying stock market
is also an option, the volatile-nature of stock trading still
makes it less attractive compared to the fixed-income mutual
funds industry.

On the supply side, an increasing number of banks are enjoying
a number of benefits by launching mutual funds -- be it on its
own, or in cooperation with fund managers.

Banks could prevent existing depositors from walking away due
to the lower interest income they would get from time deposits.

Also, by doing so, the banks could cash in part of the
government recapitalization bonds they hold, and then channel
them to the corporate sector in the form of commercial lending,
which should carry a higher interest rate.

However, this relatively new investment product -- which leads
to the fact that albeit rapidly growing, the industry is still up
to now largely unregulated -- needs safeguard measures in order
to ensure that the industry's booming trend is sustainable.

Lack of clear-cut regulations on this financial product has
caused some investors to underestimate the risks of investing in
the mutual fund industry.

As such created confusion among investors, which proved to be
costly. The most recent example was a rush by investors here to
redeem their fixed-income mutual funds. More than Rp 10 trillion
worth of funds were withdrawn from the industry from October
until mid November alone, although Bapepam said the value was
only Rp 5 trillion.

Still, it sends clear signals that the industry could well be
heading in the opposite direction.

Many reasons have been said to be behind the move. Some said
it was a physiological impact of the fact that the mutual funds
are not guaranteed under the government's blanket guarantee
program -- information that failed to be publicized by Bapepam as
the capital market watchdog. Under the blanket guarantee program,
the government would cover all obligations of banks if they go
under. But not money invested in mutual funds launched by banks.

Some also pointed at plans by the tax office to amend the
existing tax law to allow it to slap income tax on the industry.
The tax-free facility for mutual funds investing in bonds was
initially launched in 1983 and was later amended in 1994 to help
boost the domestic capital market.

Gadjah Mada University (UGM) economist Sri Adiningsih has said
that the tax-free facility could cause the government a potential
tax loss of up to Rp 2.5 trillion per annum.

The tax office is concerned that the growing number of banks
launching mutual funds could threaten the income tax revenue
targeted from the bank's time deposits this year. The government
is targeting an income tax revenue of Rp 213 trillion this year.
Tax revenue is the main source of income to finance the state
budget.

The last but probably the most foremost reason for the
redemption move was likely the plan by Bapepam to introduce a new
asset value pricing scheme called the marked-to-market pricing
system.

Under the plan, each unit of the mutual funds should represent
the value of the stocks or securities or bonds held in portfolio,
meaning that the funds should be priced on the basis of the
market value of their underlying assets.

This method is considered the most fair and common value
pricing method. Previously, most fixed-income mutual funds
managers have set their asset value based on their valuation of
the bonds in their portfolio.

Reports said the plan had created jitters among investors as
they were not used to having the price of the bonds fluctuate
based on daily movement of the market.

Whatever the reasons might be, the authority -- Bapepam, tax
office, Bank Indonesia -- have to all sit together and tackle
those problems immediately, if the country wants the mutual funds
industry to develop further in times to come.

Strong coordination among those departments is the key word to
be able to do for the best interest of this multi-institutional
industry.

While Bapepam also needs to issue regulations on the industry
as an investment instrument, as well as its trading system, the
central bank and the tax office will have to also work together
in their respective fields to help develop the industry, without
having to jeopardize their own interests.

As the World Bank puts in its report on the country's economy:
"Thus far, these sizable redemptions have not caused stress to
the system, but close monitoring by the government is needed to
ensure no liquidity problems for banks."