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What is an Arbitrage Fund
Arbitrage Funds are equity-oriented Hybrid Mutual Funds that are suitable for those investors who have a low-risk appetite. These funds dig out the advantage of the price differential between the current and future value of the securities to generate maximum profits. The fund manager tends to buy equity shares in the cash market and sell them in the future market, capitalizing on the spread between both markets.
However, the price difference in various markets can be very low, therefore the fund manager makes several trades in a day to generate better profits.
How Do Arbitrage Funds Work
Through investments in Arbitrage Funds, a fund manager evaluates the price difference of security in the spot and the futures markets. The difference between the price of the two markets is the gain for the investors. Fund managers make several trades in a day to generate returns.
Examples of arbitrage opportunities:
- Exchange Arbitrage: When the price of the same security is different in two markets at a particular time, the fund manager books profit by buying in one stock exchange and selling it to the other.
- Index Stock Arbitrage: Here the arbitrage benefit is enjoyed through the price differences between two or more market indexes.
- Cash and Carry Arbitrage: Suppose the price of a share in the cash market is Rs 1000 and its price in the Future and Options (F&O) market is Rs 1015. The fund manager locks in Rs 15 profit per share by simultaneously buying in the cash market and selling in the future market. This is the most popular Arbitrage Fund strategy of mutual funds.
Who Should Invest in Arbitrage Mutual Funds
Arbitrage Mutual Funds can be considered by investors who want to make profits from the volatility of different market situations. Investors looking for short to medium-term profit-making schemes can also choose to invest in Arbitrage Funds.
These are ideal for investors who like to invest in equity but have a low-risk appetite and they want to take advantage of equity Taxation.
Factors to Consider Before Investing in Arbitrage Mutual Funds
Following are some of the factors to consider before investing in Arbitrage Funds:
- Consider Role of The Fund Manager: The fund manager is responsible for identifying arbitrage opportunities, and reaping them to draw the best benefits. Moreover, an experienced fund manager allocates a small proportion of the portfolio to fixed-income assets to maintain fixed returns.
- Risks and Returns of Investments: As such, there is minimal risk involved in these investments as there is no pure equity exposure rather the entire portfolio is hedged. However, the returns are average, as selling in two markets with the low price difference yields smaller profits.
- Expense Ratio: This is the fee charged by the fund manager’s agency to help maintain your portfolio. Arbitrage Funds are required to be traded a number of times in a day. Thus, transaction cost accelerates eating up your profits. Choose agencies offering a low expense ratio to make better profits on your investments.
- Financial Goals: Ensure your investments meet your financial goals of the future. Arbitrage Funds are most suited for short-term and medium-term goals. You should consider investing in these funds instead of opting for regular saving schemes to help generate better returns.
- Funds Performance: Consider measuring the fund performance in all types of markets, viz. bear and the bull market. However, Arbitrage Funds are considered to be comparatively reliable and offer low-risk returns, it is good to research their performance before any investments are done.
Taxation of Arbitrage Funds
One of the best advantages for the investors opting for the Arbitrage Fund, is equity taxation, as these funds are taxed similar to equity funds. Profits incurred from these funds when the funds are held for less than 12 months are considered as Short-Term Capital Gains and are taxed at the rate of 15%.
While gains earned when investments are held for more than 12 months are known as Long-Term Capital Gains and are taxed at 10% without indexation benefits. Profits of up to Rs. 1 Lakh are tax exempted in a single financial year.
How to Invest in Arbitrage Funds with Nivesh
Any investor can enjoy the benefits of investing through Nivesh in the following easy steps:
- Create an account in Nivesh by providing your basic KYC details. (If you already have an account then just login into your account)
- On your portfolio page click on the Buy New tab at the right top corner of the screen.
- Select the category and choose the funds you want to purchase.
- If you already know the name of the fund to buy, then you can search the particular fund through Quick Order.
- Fill the transaction details and confirm. You can place up to 5 orders in one go.
- You can make payment through your registered account through UPI, Direct Pay, or NEFT/ RTGS , Bank Mandate or Cheque. For same-day NAV, select UPI, Direct Pay or NEFT / RTGS as other payment options may take a few days to clear, Nodal account takes about 1-2 days to clear payment from the approved mandate and cheque takes about 2-5 days in clearing due to which you will not get the same-day NAV.
Frequently Asked Questions (FAQs)
1. Are Arbitrage Funds Safe to Invest?
As such, there is minimal risk involved in these investments as there is no pure equity exposure rather the entire portfolio is hedged. However, the returns are average, as selling in two markets with the low price difference yields smaller profits.
2. How Much Share Of The Portfolio Should be Invested In Arbitrage Funds?
A small part of an investor’s portfolio can be set aside to invest in Arbitrage Funds with the goal of achieving some Short-Term financials goals.
3. Where do Arbitrage Funds Invest?
Arbitrage Funds work on the strategy of buying and selling equity shares in the spot and futures markets. These funds generate profit with the price difference between current and future securities.
4. Who Should Invest in Arbitrage Funds?
Arbitrage Funds are safer investments in comparison to other mutual fund schemes. New investors looking for short-term gains and want to invest in low-risk funds can opt for Arbitrage Funds.
5. What is the Lock-in Period for Arbitrage Funds?
There is no such lock-in period for Arbitrage Funds. However, the investors are advised to maintain at least a holding period of four to six months, before starting calculating their profits.
6. How are Arbitrage Funds Taxed?
Arbitrage Funds are treated as Equity Funds for the purpose of taxation. Investments for less than one year are STCG and are taxed at the rate of 15%, while investments for more than one year are LTCG and are taxed at the rate of 10% without the benefit of indexation. Moreover, profits of up to Rs. 1 Lakh are tax exempted for a given financial year.
