Arbitrage Funds

Arbitrage Funds

ABOUT

Arbitrage fund is a type of mutual fund that leverages the price differential in the cash and derivatives market to generate returns. The returns are dependent on the volatility of the asset. These funds are hybrid in nature as they have the provision of investing a sizeable portion of the portfolio in debt markets. For instance A company’s share might sell at 20 per share today, but perhaps the majority of investors feel the company is primed for a spike next month. In that case, a futures contract with a maturity date one month down the road may be valued much more highly. The difference between the cash and futures price for ABC stock is called the arbitrage profit. Arbitrage funds take advantage of these different prices. They buy stock in the cash market and simultaneously sell a contract for it on the futures market if the market is bullish on the stock.

WHY TO INVEST?

Arbitrage funds are apt for those investors who are looking to have equity exposure but are worried about the risk associated with the same. Arbitrage funds are a safe option for risk-averse individuals to safely park their surplus funds when there is a persistent fluctuation in the market.

WHO TO INVEST? 

Arbitrage funds are a good choice for cautious investors who want to benefit from a volatile market without taking on too much risk. 

Secondly, they are taxed as Equity Funds. Arbitrage funds are technically balanced or hybrid funds because they invest in both debt and equity, but they invest primarily in equities. Therefore, they are taxed as equity funds since long equity represents an average of at least 65 per cent of the portfolio

Arbitrage Funds vs. Mutual Funds 

• Liquid funds are considered safer than arbitrage funds. A liquid fund invests in debt instruments with a short maturity period (91 days). An arbitrage fund invests in equity and relies on arbitrage opportunities.

• Both liquid funds and arbitrage funds deliver similar returns over the long term in the range of 4-7%. However, arbitrage funds can use arbitrage opportunities to deliver better short term returns.

• Arbitrage funds may be more tax-efficient than liquid funds based on your tax bracket. This is because arbitrage funds are treated as equity funds during taxation.

• Arbitrage funds may have a comparatively higher expense ratio than liquid funds due to the heavy reliance on the fund manager’s ability to use arbitrage opportunities to deliver profits.

• Liquid funds, as the name suggests, are better than arbitrage funds in terms of liquidity. You can withdraw your money from a liquid fund in 1-2 days while it might take 3-5 days to withdraw money from an arbitrage fund. Some liquid funds even have an instant redemption feature.

PROS 

• Low risk because each security is bought and sold simultaneously; there is virtually none of the risk involved with longer-term investments. Arbitrage funds also invest part of their capital into debt securities, which are typically considered highly stable

• Actively managed as If there is a shortage of profitable arbitrage trades, the fund invests more heavily in debt

• Arbitrage funds flourish when the market is highly volatile. That is because volatility leads to uncertainty among investors. The differential between the cash and futures markets increases when prices are unstable.

CONS 

• Arbitrage funds are not very profitable during stable markets. If there are not enough profitable arbitrage trades available, the fund may essentially become a bond fund, albeit temporarily. Excessive time in bonds can drastically reduce the fund’s profitability, so actively managed equity funds tend to outperform arbitrage funds over the long term.

• The high number of trades required by successful arbitrage funds means their expense ratios can be quite high. Experts say, even though arbitrage funds can be a highly lucrative investment, especially during periods of increased volatility, their inadequate reliability and high expenses indicate that they should not be the only type of investment in a portfolio.

HOW TO INVEST?

These are the best rated and high yielding Arbitrage funds:-

• HDFC Arbitrage Fund Wholesale Plan Growth Option Direct Plan- Yielding 2.40% returns in 6 months, 4.5% returns in a year and 31.85 % returns in 3 years 

• Edelweiss Arbitrage Fund Direct Growth- Yielding 2.49% returns in 6 months, 4.67% returns in a year and 35.28% returns in 5 years 

• Nippon India Arbitrage Fund Direct Plan Growth- Yielding 2.50% returns in 6 months, 4.64% returns in a year and 35.33% returns in 5 years