What is Arbitrage Fund-all about? Investors in the market are on the lookout for instruments having a good combination of stability and reasonable return. Arbitrage Fund serves all that purpose by capitalizing on the price difference between the cash and futures markets. It is for all those investors who want low-risk investments, having some better tax efficiency than those seen with investments in traditional debt. Knowing all about how these Funds work, from how they generate returns to what tax benefits they provide to investors, would help in making informed Investment App or platform choice.
What Are Arbitrage Funds?
Arbitrage funds fall under the group of hybrid mutual funds, which capitalize on temporary price differences of the identical asset across different markets. Such temporary price differences often occur between the cash (spot) market and futures market.
Take, for instance, if a stock is trading at ₹1,000 in the cash market and there is this futures contract trading at ₹1,010, the fund manager would buy that stock in the cash market and then sell the futures contract simultaneously. What that gives internally to the fund is a near-risk-free profit of ₹10 because assuming the prices converge near the expiration of the futures contract. In the budding of arbitrage, this is actually the purchase of low sell-high.
Arbitrage means buying low and selling high at different markets, and they give a small number of opportunities to form the aggregate returns over the long term.
How Arbitrage Funds Work
These funds capitalize on temporary price inefficiencies. The following is the simplified version of that process:
- Spot Futures: The Fund Manager buys the stock from the cash market and sells its futures contract. When both prices converge, the difference is pure profit.
- Balance and Renew: A fund manager has multiple arbitrage techniques. Since arbitrage opportunities are short-lived, the fund manager would often roll over positions to look for new opportunities.
- Short-term Instruments: When there is no profitable arbitrage, a part of the money is invested in short-term debt or money market instruments to provide liquidity and return.
Thus, an arbitrage fund becomes a hybrid product between equity and debt based on market conditions and available arbitrage spreads.
Who Should Invest in Arbitrage Funds
Investors with low risk with better tax efficiency are the right investors for actionable arbitrage funds. It is for:
A conservative investor looking to invest in something other than liquid or ultra-short-term debt funds.
Short-term investors who do not expect to leave anything in the scheme for more than a few months will concede a bit of volatility with their surplus funds.
Tax-sensitive investors wanting to take neuro stasis under the equity taxation regime benefits.
Investors can access these schemes easily through any investment app, track their daily net asset value (NAV) variations, and redeem or reinvest as per liquidity requirements.
Tax Efficiency of Arbitrage Fund
One of its greatest assets is the tax treatment of these funds. These funds behave like debt funds with regard to the risk-return approach, but since they invest at least 65% of assets in equity or equity-related instruments, they are classified as equity-oriented funds in terms of taxation.
- Short-Term Capital Gains (STCG): Gains from units held for less than 12 months are taxed at 15%.
- Long-Term Capital Gains (LTCG): Gains from units held over 12 months are charged at 10% if they exceed ₹1 lakh in a financial year.
The good side about this kind of taxation is that it makes arbitrage funds effective for short-term parking compared to conventional debt-oriented products, especially for investors in a high-income bracket.
Benefits of Investing in Arbitrage Funds
- Less Market Risk: The buy-sell position in different markets reduces exposure to price fluctuation.
- Liquidity: Most funds allow redemption in a few business days which makes them useful for short-term objectives.
- Tax Benefit: The treated as equity, thus providing a tax benefit, even though the risk profile is less.
- Regular Opportunity: In volatile markets, such disparities in prices create multiple arbitrage opportunities, stabilizing income.
While investment apps make monitoring and tracking portfolio performance and arbitrage spreads easy, it also ensures that active trading is not required by the investor.
Risks and Disadvantages
These tend to be low-risk funds, but they are not risk free. Some of the points are:
- Reduced Opportunities: Price gaps tend to narrow in the absence of large movements in the cash and futures markets; hence less potential return.
- Liquidity-risks: Delays in settlement or redemption may occur, although rare, during periods of extreme market stress.
- Short-term nature: The length of time arbitrage funds are held does not make them ideal for creating long-term wealth, as returns are based on short-term inefficiencies.
Investors should consider putting these funds as short- or low-risk allocation in a longer equity portfolio rather than investing core equity in them.
Conclusion
ArbitrageFunds gives a balanced stance to investors who look for stable tax-efficient returns for his investment. It uses short-term market disparities-in-ef-ficiency and generates steady results with low volatility over time. This Fund can also be accessed directly through any Investment App, helping the investor diversify his/her portfolio while optimizing the post-tax gains. Investors considering parking surplus cash or maintaining liquidity without taking excessive market risk can find an efficacious investment road in arbitrary funds.
