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What are Arbitrage Funds and How it Works?
Mutual funds are popular investment instruments. These investment vehicles offer investors a window to invest in various asset classes and get consistent returns. However, the presence of different types of mutual funds often confuses investors. Here, experienced investors who are willing to leverage market volatility can find the Arbitrage mutual fund an ideal investment option.
Want to know about the Arbitrage mutual fund, its benefits, and its working procedure? Read along!
Table of Contents
What are Arbitrage Funds?
Arbitrage mutual funds are equity-oriented funds. In mutual funds, ‘Arbitrage’ refers to the purchasing and selling of currencies, commodities, and securities from different markets where investors can benefit from different price points.
Arbitrage mutual funds are invested in stocks and equity derivative securities of similar volume and securities. Thus, these funds can leverage the price differences between two market segments.
As the meaning of Arbitrage mutual funds is now clear to investors, let’s learn about the working procedure of the same.
How Does an Arbitrage Fund Work?
In the case of an Arbitrage mutual fund, fund managers assess the price differences in securities of the spot and futures market. Here, if fund managers find that the price is at an increased level in the spot market, they purchase that security in the futures market. Simultaneously, the fund manager sells off the same volume of security in the spot market. Here, the fund manager benefits from the price difference of securities in both markets. Remember, this gain does not include other expenses.
Refer to the following example to understand it better.
Suppose Company ABC has traded equity shares at ₹ 1100 in the cash or spot market and at ₹ 1125 in the futures market. A fund manager purchases shares from the cash market at ₹ 1100 and sorts a futures contract to sell shares at ₹ 1125. At the end of the month, if the fund manager sells shares in the futures market, he/she will get ₹ 25 per share as profit after deducting transaction costs.
Benefits of Investing in Arbitrage Funds
Arbitrage mutual funds can offer a few benefits to investors. These are as follows:
1. Convenient for Volatile Market
Several investors do not find a volatile market ideal for investment. However, for Arbitrage mutual funds, the volatile market offers a perfect investment environment. During volatile situations, individual share prices experience massive fluctuation. Here, Arbitrage mutual funds utilize this market volatility by instantly purchasing and selling in diverse markets.
2. Low-Risk
One of the prime benefits of investing in arbitrage mutual funds is the low-risk factor associated with it. As fund managers purchase and sell securities instantly, there is no risk of being tied up with the cons of long-term investments.
3. Taxed as Equity Funds
The taxation of an Arbitrage mutual fund occurs similarly to that of an equity fund (65% of assets are invested in equities). Investors who can hold these funds for one year or more can gain tax benefits as the taxation on gains is fixed at the capital gains rate. To be precise, investors will be taxed at 15% for short-term capital gains (less than 1 year). On the other hand, investors will be taxed at 10% without indexation benefits for long-term capital gains (more than 1 year and above ₹ 1 lakh).
Who Should Invest in Arbitrage Mutual Funds?
How to Invest in Arbitrage Mutual Funds?
Investors willing to purchase Arbitrage mutual funds can follow the steps mentioned below.
Step 1
Create a mutual fund account with an Asset Management Company and sign up.
Step 2
Provide KYC details in case investors have not submitted them before.
Step 3
Enter the required details. Select the right funds and invest in mutual funds.
Step 4
Select an open-ended Arbitrage mutual fund as per your preference and transfer the amount.
Note: Investors can also invest via SIP.
Factors to Consider Before Investing in Arbitrage Funds
Before investing in any securities, investors must consider certain factors. These are as follows:
1. Cost of Investment
There are different costs associated with a mutual fund, such as entry load and exit load. Hence, knowing these costs is essential for investors. As Arbitrage mutual funds involve frequent trading, investors have to bear increased transaction costs.
2. Investment Horizon
Investors with a medium-term investment horizon, i.e., 3-5 years, can invest in an Arbitrage mutual fund. As these funds come with an entry and exit load, investors who are considering staying invested at least for a certain time can choose this. Remember, Arbitrage mutual funds perform well during volatile market conditions. Therefore, assess the market scenario well before investing in an Arbitrage mutual fund.
3. Financial Goals
For investors, maintaining a perfect alignment between the fund objective and the financial goal is important. Investors who have medium-term financial goals can find the Arbitrage mutual fund an ideal investment option. Here, investors can park their surplus funds in an Arbitrage mutual fund and generate higher returns than investing the same amount in a savings account.
4. Risks and Returns
As stated earlier, the Arbitrage mutual fund is a low-risk investment instrument (as investment occurs on bonds that offer low yield) and performs well in volatile market conditions. Hence, investors who have compact knowledge about the inner workings of this fund and expect moderate returns (approx.. 8% if investors stay invested for 5-8 years) can invest in the Arbitrage mutual fund.
5. Fund Performance
Before investing, investors must evaluate a fund’s performance in both a bearish and bullish market. This evaluation enables investors to identify a suitable and reliable fund. Arbitrage mutual funds stand midway in terms of reliability. As investors know that these mutual funds perform efficiently in volatile market conditions, they must invest accordingly.
6. Tax Benefits
Assessing the tax benefit of any mutual fund is imperative while making an investment. Arbitrage mutual funds offer tax benefits in a similar way to equity funds (discussed earlier). Hence, investors can earn tax-efficient returns.
Disclaimer: The information provided on this website is for general informational purposes only and should not be construed as financial, investment, or legal advice. While we strive to provide accurate and up-to-date content, we do not guarantee the completeness, reliability, or suitability of the information for your specific needs.
We do not promote or endorse any financial product or service mentioned in these articles. Readers are advised to conduct their own research, consult with financial experts, and make informed decisions based on their unique financial circumstances. Any reliance you place on the information provided here is strictly at your own risk.
FAQs about Arbitrage Funds
What are the rates of tax for less than ₹ 1 lakh and an investment period of more than 1 year in the case of an Arbitrage mutual fund?
Does an Arbitrage mutual fund offer a profitable return during a stable market?
What are arbitrage funds?
What are the benefits of arbitrage funds?
- Low Risk: Arbitrage funds are considered low-risk investments because they capitalise on price discrepancies that are typically small and short-lived.
- Liquidity: Arbitrage funds offer high liquidity, making it easy for investors to enter and exit positions.
- Stable Returns: While the returns may not be very high, they are generally stable and predictable, making arbitrage funds a good option for conservative investors looking for steady growth.
Other Important Articles about Mutual Funds
Disclaimer
- This is an informative article provided on 'as is' basis for awareness purpose only and not intended as a professional advice. The content of the article is derived from various open sources across the Internet. Digit Life Insurance is not promoting or recommending any aspect in the article or its correctness. Please verify the information and your requirement before taking any decisions.
- All the figures reflected in the article are for illustrative purposes. The premium for Coverage that one buys depends on various factors including customer requirements, eligibility, age, demography, insurance provider, product, coverage amount, term and other factors
- Tax Benefits, if applicable depend on the Tax Regime opted by the individual and the applicable tax provision. Please consult your Tax consultant before making any decision.
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