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Mutual funds are popular investment instruments. These investment vehicles offer investors a window to invest in a variety of 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 working procedure? Read along!
Arbitrage mutual funds are equity-oriented funds. In mutual funds, ‘Arbitrage’ refers to 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.
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 the Company ABC has traded equity shares at ₹ 1100 in 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.
|
Particulars |
Amount |
|
Equity share of ABC in cash or spot market |
₹ 1100 |
|
Equity share of ABC in futures market |
₹ 1125 |
|
Fund manager’s expense on share |
₹ 1100 |
|
Fund manager’s sale |
₹ 1125 |
|
Profit of the fund manager |
₹ 25/per share |
Arbitrage mutual funds can offer few benefits to investors. These are as follows:
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 utilise this market volatility by instantly purchasing and selling in diverse markets.
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.
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 a period of 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).
As stated earlier, Arbitrage mutual funds can generate consistent returns for a certain time from arbitrage active in prices of stocks or futures.Â
Refer to the table mentioned below to get a clear picture of Arbitrage mutual fund returns.
|
Name of the Fund |
Returns in 5 Years |
|
Nippon India Arbitrage mutual fund - Direct Plan-growth |
5.93% |
|
Edelweiss Arbitrage mutual fund - Direct Plan-growth |
5.92% |
|
Axis Arbitrage mutual fund - Direct Plan-growth |
5.86% |
|
L& T Arbitrage Opportunities Fund- Direct Plan-growth |
5.84% |
|
Kotak Equity Arbitrage mutual fund - Direct Plan-growth |
5.80% |
|
Baroda BNP Paribas Arbitrage mutual fund - Direct Plan-growth |
5.80% |
|
Aditya Birla Sun Life Arbitrage mutual fund - Direct Plan-growth |
5.72% |
|
UTI Arbitrage mutual fund - Direct Plan-growth |
5.71% |
|
IDFC Arbitrage mutual fund - Direct Plan-growth |
5.70% |
|
ICICI Prudential Equity Arbitrage mutual fund - Direct Plan-growth |
5.67% |
Arbitrage mutual funds are ideal for those who are willing to take advantage of the volatile market without pushing their investments to high risk. Investors can compare the risk level of an Arbitrage mutual fund to that of a debt fund. Therefore, investors looking for low-risk investment instruments and who have small-scale equity exposure can 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 Asset Management Company and sign up.
Step 2 – Provide KYC details in case investors have not submitted it 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.
Before investing in any securities, investors must consider certain factors. These are as follows:
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.
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.
For investors, maintaining a perfect alignment between the fund objective with 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.
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.
Before making an investment, 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.
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.
For making an informed investment decision, knowing the above-mentioned pointers is necessary. Therefore, select a suitable Arbitrage mutual fund as per your investment horizon, financial goals and risk tolerance.
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