What is Arbitrage Fund? Is It Good to Invest In It?

Arbitrage funds are a category of mutual funds. These funds take advantage of the price differences in the cash and derivatives market to generate profits.

What is Arbitrage Fund?

Arbitrage funds invest in commodities, currencies and stocks which leverage price differences across markets. The word arbitrage clearly explains how arbitrage funds work. Arbitrage means simultaneous buying and selling of equities and other securities and generating returns from the price differences of same assets in different markets.

Generally, arbitrage funds are bought in cash market and sold in futures markets. Futures market is where futures contracts are traded on a stock exchange. That is, contracts to buy a specific commodity, at a specific price on a future date called expiry date.

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What is Arbitrage Fund? Is It Good to Invest in It?

How do Arbitrage Funds Work?

An investor, who is interested in arbitrage trading, compares the price of an equity share in the cash market as well as futures market. Suppose the price of company A in the cash market is Rs 1000 and in the futures market is Rs 1200, then the investor buys this share and enters into a future contract to sell them at Rs 1200. Later, if the prices coincide on expiry date, the investor will sell the shares at Rs 1200 and make a profit.

See Also: What You Must Know About Mutual Funds?

Things to Know While Investing in Arbitrage Fund

1. Risk: These are low risk funds. This is because the fund managers are involved in a buy and sell activity simultaneously in the cash market and futures market.
2. Returns: These funds have returned 7-8% in the past if the funds are held for a long time (5-10 years). However, returns are not guaranteed.
3. Cost: Arbitrage funds include an annual fee which is a percentage of the fund’s asset. Fund manager’s fees and management charges are included in this fee. As the fund involves frequent trading activities, the expense ratio is likely to be higher. It also involved an exit load.
4. Investment Horizon: This is for a moderate investment horizon of 3-5 years. As it involves high volatility, lump sum option is preferred over SIP and proves to be more beneficial.
5. Fund House: Performance of mutual funds is highly dependent on the fund manager’s expertise. So make sure to choose a fund house that has witnessed good performance in the past.
6. Financial Goal: To extract the benefits of any investment, ensure your personal goals are aligned with the nature of the fund. If you are looking forward to invest for a short to moderate time period, with low risk, tax benefits and as an edge over debt funds, then arbitrage funds are an ideal option.

See Also: Hedge Funds In India

Why Should You Invest in Arbitrage Fund?

1. Due to Low Risk: Risk involved in arbitrage funds is low. If the investor’s objective is to invest in equity and at the same time enjoy the low risk of debt funds, then arbitrage funds are an ideal option.
2. Suitable for Unstable Markets: One major advantage of arbitrage funds is that it helps eliminate the risk generally associated with unstable markets. Unstable markets are characterized by negative returns and unpredictability. But in this case, volatility and gains go hand in hand. Therefore, these are suitable for unstable markets.
3. Tax Benefits: Although these are hybrid funds, they are taxed as equity funds. If the fund is held for more than a year, then profits are treated as long term capital gains. If they are held for less than a year, then gains are treated as short term capital gains and are taxed at 15%.

See Also: What is Arbitrage Trading?

Risk of Investing in Arbitrage Fund

1. Debt: Investors often have a misconception that arbitrage funds invest only in equity. Although it’s mandatory to have 65% invested in equity, when arbitrage opportunities arise they do invest in debt. This means there’s interest rate risk and credit risk in arbitrage funds.
2. Lack of Arbitrage Opportunities: Arbitrage opportunities are present in unstable markets, where the prices are falling or rising. It is not possible to find these opportunities when the market is stable. Without arbitrage opportunities, these funds cannot generate good returns.
3. Small losses: Once an arbitrage trade generates profit, it can be realized only after the trade is settled. In case the gap widens, there would be losses. Hence small losses do occur.

Top 5 Arbitrage Funds 2020

SL NO	FUND NAME	1 YEAR RETURNS (%)	3 YEAR RETURNS (%)	5 YEAR RETURNS (%)
1.	Axis arbitrage fund	6.82	6.72	7.07
2.	Edelweiss arbitrage fund	6.97	6.86	7.11
3.	ABSL arbitrage fund	6.93	6.70	6.94
4.	Kotak equity arbitrage fund	6.71	6.71	6.95
5.	Nippon India arbitrage fund	6.90	6.94	7.17

Conclusion

Arbitrage funds are a category of hybrid funds ideal for investors who want to park their money for the short term. This gives an opportunity to gain exposure to equity with less risk. It is wise to invest in arbitrage funds when the market is fluctuating.

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