In this article, we will discuss Arbitrage Mutual Funds in detail, exploring their features and important aspects that investors should be aware of before investing.
Arbitrage Mutual Funds
Arbitrage is considered by many investment experts as a lucrative method to generate wealth. It involves capitalizing on price differences of the same security in multiple markets. For example, if a stock’s price is higher in the futures market compared to the spot market, investors can take advantage of this price discrepancy.
However, successfully implementing arbitrage strategies requires extensive research and a deep understanding of market dynamics. Many investors may lack the necessary knowledge or time to conduct such research. This is where Arbitrage Mutual Funds come into play. These funds are designed to carry out arbitrage trading on behalf of investors, eliminating the need for individual research.
In this article, we will discuss Arbitrage Mutual Funds in detail, exploring their features and important aspects that investors should be aware of before investing.
What are Arbitrage Funds in India?
Arbitrage funds are a type of equity-oriented hybrid funds that take advantage of pricing discrepancies in the market. These discrepancies can arise from differences in prices between different exchanges or variations between spot and futures markets. The fund manager of an arbitrage fund engages in simultaneous buying and selling of shares to profit from the price difference.
This approach differs from traditional investing methods, where an asset is purchased and held for potential growth before selling. In arbitrage funds, the fund manager only invests in equities when there is a clear opportunity for returns. If no arbitrage opportunities are available, the fund invests in short-term money market instruments and debt securities. It’s worth noting that the price differences in arbitrage are typically small, requiring multiple trades to generate a reasonable profit.
How do Arbitrage Mutual Funds work?
There are two scenarios in which arbitrage opportunities can arise:
Scenario #1: Price disparities between exchanges
If a stock, such as XYZ Limited, is priced at Rs. 1000 per share on one exchange (BgSE) and Rs. 1010 per share on another exchange (ASE), an arbitrageur can buy shares from the lower-priced exchange and sell them simultaneously on the higher-priced exchange. This allows them to profit from the Rs. 10 price difference per share, taking into account transaction costs, without assuming any risks.
Scenario #2: Price discrepancies between cash and futures markets
In this case, if XYZ Limited’s share is priced at Rs. 1000 in the cash market and Rs. 1015 in the futures market, an arbitrageur can purchase shares from the cash market and simultaneously create a futures contract to sell the shares at Rs. 1015. At the end of the contract period, they can sell the shares in the futures market, earning a profit of Rs. 15 per share (after deducting transaction costs) without exposing themselves to any risks.
Who should invest in Arbitrage Mutual Funds?
Arbitrage funds have a risk profile similar to that of debt funds. Some arbitrage funds use the liquid fund index as their benchmark. These funds are suitable for investors who desire to invest in equity but are not willing to take on the associated risks. During market fluctuations, risk-averse investors often choose to invest their money in arbitrage funds, as they can earn favorable returns.
Factors to consider before investing in Arbitrage Mutual Funds in India
Before investing in arbitrage funds in India, it is important to consider the following factors:
- Role of the Fund Manager: The fund manager plays a crucial role in identifying and capitalizing on arbitrage opportunities. They also allocate a portion of the assets to fixed-income instruments for stability during periods with limited arbitrage opportunities.
- Risks and Returns: Arbitrage funds involve buying stocks in one market and selling them simultaneously in another, minimizing equity exposure risk. However, the opportunities for arbitrage can be limited, resulting in average returns. Investors can expect returns of around 8% over 5-8 years, but there are no guaranteed returns.
- Expense Ratio: The expense ratio is the fee charged by the fund house for managing the fund. In arbitrage funds, frequent trading leads to significant transaction costs. It is important to be aware of the expense ratio and any additional charges, such as exit loads for redeeming units within a certain period.
It is essential to carefully evaluate these aspects and consult with a financial advisor or conduct thorough research before making any investment decisions in arbitrage funds in India.
Invest according to your Investment Plan
To earn reasonable returns from arbitrage funds, it is generally recommended to have a minimum investment horizon of 3-5 years. It’s important to consider the exit load charged by most arbitrage funds before investing. These funds tend to perform well in volatile markets, so it is often more beneficial to invest a lump sum rather than through a systematic investment plan.
However, if the markets are not volatile, liquid funds may offer better returns. Instead of keeping your funds in a regular savings account, investing in an arbitrage fund can help generate higher returns. If you already have investments in equity-oriented funds, you can opt for a systematic transfer plan from the equity fund to the arbitrage fund to reduce risk.
Benefits of Investing in Arbitrage Funds
In terms of taxation, arbitrage funds are treated similarly to equity funds. Short-term capital gains are taxed at 15%, while long-term capital gains are taxed at 10% without indexation. For individuals in higher tax brackets, investing in an arbitrage fund is advantageous compared to investing in a debt fund and paying more tax on the gains.
Top Arbitrage Funds in the Market
- Invesco India Arbitrage Fund
- Tata Arbitrage Fund
- Edelweiss Arbitrage Fund
- Kotak Equity Arbitrage Fund
- Nippon India Arbitrage Fund
- Axis Arbitrage Fund
- HSBC Arbitrage Fund
- Aditya Birla Sun Life Arbitrage Fund
Tips for Selecting the Right Arbitrage Fund
When selecting an arbitrage fund, consider the following tips:
Fund Performance: Look for funds with a consistent track record of performance and competitive returns. Analyze their historical returns over various time periods and compare them with benchmark indices and peers.
Expense Ratio: Consider the expense ratio of the fund, which includes management fees and other expenses. Lower expense ratios can contribute to higher net returns.
Fund Size: A larger fund size generally indicates investor confidence and stability. However, it’s essential to strike a balance as excessively large funds may face challenges in deploying capital efficiently.
Risk Management: Evaluate the fund’s risk management practices and the extent to which they mitigate downside risks. A focus on risk control and adherence to investment guidelines is crucial in arbitrage funds.
Fund Manager Expertise: Assess the experience, track record, and expertise of the fund manager. A skilled and experienced fund manager can play a significant role in the fund’s performance.
Fund House Reputation: Consider the reputation and credibility of the asset management company managing the fund. Look for a fund house with a strong track record, good governance practices, and investor-friendly policies.
List of Arbitrage Mutual Funds in India
Here is a list of some popular arbitrage mutual funds available in India:
- ICICI Prudential Equity Arbitrage Fund
- Reliance Arbitrage Fund
- HDFC Arbitrage Fund
- Kotak Equity Arbitrage Fund
- SBI Arbitrage Opportunities Fund
- Axis Equity Saver Fund
- Aditya Birla Sun Life Equity Savings Fund
- IDFC Arbitrage Fund
- Nippon India Arbitrage Fund
- UTI Spread Fund
Please note that this list is not exhaustive, and there are other arbitrage mutual funds offered by different asset management companies in India. Before investing, it is recommended to conduct thorough research, evaluate the fund’s performance, consider the fund’s investment objective and strategy, and consult with a financial advisor to determine the suitability of the fund for your investment goals and risk appetite.
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