An arbitrage fund generates returns on the price differential in the cash and futures market. In such a scheme, the fund manager simultaneously buys a stock in the cash market and sells an equivalent quantity in the futures segment, thereby generating a return for the scheme. The fund manager will not take any naked exposure in stocks or an index as each buy transaction in the cash market has a corresponding sell transaction in the futures market. According to regulatory requirements, at least 65% of the corpus is allocated to arbitrage products, while the fund manager is free to choose the remaining 35% between arbitrage or debt products, depending on his view on the market.
WHY ARE INVESTORS CHOOSING ARBITRAGE FUND?
Amid a rising stock market and increasing volatility, there are higher opportunities in arbitrage trades. High returns compared with savings accounts and better taxation are attracting investors to arbitrage funds. HNIs prefer these funds as they are treated as equity funds for taxation, which significantly increases post-tax returns. Investors holding such schemes for less than a year pay 15% capital gains tax, while if they sell after a year, they pay only 10% long-term capital gains tax. As compared with this, in a debt fund, rich investors have to pay short-term capital gains tax, which is 30%.
DO THEY CARRY ANY RISK?
Arbitrage funds rank high on safety. The scheme always has a market- neutral position by buying in the cash market and simultaneously selling the same security in the futures market. Compared with debt funds, where there could be some credit risk, there is no such risk here. As indices clock all-time highs and more investors turn to the stock markets, there is increased participation from both institutional and retail investors in the F&O segment, leading to higher volatility and demand for money. That, in turn, pushes up returns in these schemes.
WHAT RETURNS HAVE THEY GENERATED IN THE PAST?
Over the last one year, data from Value Research showed arbitrage funds generated 7.1% returns. This is higher than savings bank accounts that generate 2.7-3%.
Disclaimer: – Mutual funds investments are subject to market risk. Please read the offer documents carefully before investing.
