Arbitrage Funds are a special type of mutual fund that helps you safely grow your money. They work by buying and
selling the securities in cash and derivative markets at the same time to make a small profit from the price
difference. It's like buying a thing from one shop for less and selling it in another shop where it costs more.
These funds don’t get affected much if the market goes up or down, which makes them less risky. They are a good
choice for people who want to earn steady returns without too much worry, especially when things in the market are
changing a lot.
What are Arbitrage Funds?
What is an Arbitrage Mutual Fund at its core? These are equity-oriented hybrid Mutual Funds that aim to exploit price
differentials between markets. An Arbitrage Mutual Fund's meaning encompasses the strategy of simultaneously
purchasing and selling the same security in different markets (cash and derivatives) to profit from the price
difference.
Features of Arbitrage Funds
- Equity-oriented composition: At least 65% of the portfolio must be invested in equities and
equity-related instruments.
- Hedged exposure: Primarily maintains hedged positions to minimise market risk.
- Low volatility: Provides relatively stable returns compared to pure Equity Funds.
- Market sensitivity: Tends to perform better during volatile or bullish markets, when arbitrage
opportunities are abundant.
- Tax efficiency: Enjoys equity taxation despite having hybrid characteristics.
How do Arbitrage Funds work?
What are Arbitrage Funds in practice? They operate on a simple principle: markets aren't perfectly efficient,
creating temporary price discrepancies. Consider this example:
- A company's shares trade at ₹1,000 in the cash market.
- The same company's futures contract trades at ₹1,060 (due to premium).
- The fund manager buys shares at ₹1,000 in the cash market.
- Simultaneously, the manager sells futures contracts at ₹1,060.
- At futures expiry, regardless of price movement, the fund locks in a profit of ₹60 per share (minus costs).
- This strategy ensures profits irrespective of whether the market rises, falls, or remains flat, as the opposing
positions offset price risk while capturing the differential.
Benefits of investing in Arbitrage Funds
- There is virtually no price risk, as the equity exposure is fully hedged, ensuring safety during all types of
market movements.
- There is no counterparty risk because stock exchanges guarantee settlement, ensuring secure and reliable trade
execution.
- These funds offer the potential for substantial gains during volatile markets by taking advantage of wider price
differences.
- Despite being hybrid in structure, Arbitrage Funds enjoy favourable taxation similar to Equity Funds, offering
better post-tax returns.
- They provide moderate yet relatively stable returns when compared to pure Equity Funds, making them suitable for
cautious investors.
- Arbitrage Funds are ideal for parking for short term period, offering liquidity and consistent returns with
lower risk.
How should you invest in Arbitrage Funds?
When considering what is an Arbitrage Fund investment, a lump sum approach typically works better than SIP, as these
funds aim to capitalise on point-in-time price differentials.
Before investing, thoroughly review:
- The scheme's offer document detailing investment objectives and strategy.
- Asset allocation between equity and debt components.
- Fund manager's experience and track record.
- Management fees and their impact on net returns.
- Risk factors specific to the fund's approach.
Taxation rules of Arbitrage Funds
They qualify for equity taxation if at least 65% of assets are in equities. This means:
- Short-term capital gains (STCG held less than 12 months) will be taxed at 20%.
- Long-term capital gains (LTCG) exceeding ₹1.25 lakh will be taxed at 12.5%.
- This tax efficiency gives them an edge over Debt Funds for many investors.
Also Read: Consolidated account statements (CAS) in Mutual Funds
Conclusion
What is an Arbitrage Mutual Fund if not a unique investment vehicle that bridges the gap between risk and return?
These funds offer a compelling option for conservative investors seeking reasonable returns with minimal risk. By
exploiting market inefficiencies, Arbitrage Funds deliver consistent performance regardless of market direction.
While not a substitute for traditional equity or debt allocations, they provide an interesting alternative for
short-term investments while benefiting from equity-like taxation. As with any investment, aligning with your risk
profile and financial goals remains paramount when considering what Arbitrage Funds are for your portfolio.
Disclaimer: This article is for information purpose only. The views expressed in this article
are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd.
and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader
for taking any financial decisions based on the contents and information. Please consult your financial advisor
before making any financial decision.
Mutual Fund investments are subject to market risk, read all scheme related documents carefully. Axis Bank Ltd
is acting as an AMFI registered MF Distributor (ARN code: ARN-0019). Purchase of Mutual Funds by Axis Bank’s
customer is purely voluntary and not linked to availment of any other facility from the Bank. T&C apply.
