Should mutual fund investors consider investing in arbitrage funds?

Should mutual fund investors consider investing in arbitrage funds?

The investors who are looking for tax-efficient returns and do have a time frame of one month are recommended to opt for these types of equity funds said by the financial planners.

What is an arbitrage fund?

Arbitrage mutual fund is the simultaneous buying and selling of an asset in different markets to benefit from the price difference.
However, the safety of a financial instrument can again be divided into two parts:

  1. Assurance of capital protection
  2. Assurance of returns

As far as bank FD’s (Fixed deposits) is concerned, your money is safe on both aspects, i.e., your capital is protected and return is guaranteed. However, in the arbitrage fund, only the first one holds true. Since arbitrage itself means risk-free profit opportunity, there is virtually no risk of the fund value going down once in every few days, the Net Asset Value(NAV) may fall by a bit though. But when it comes to assured returns, that is not there in arbitrage funds. Your returns will be variable and you can’t be sure of how much profit you’ll earn. So no, Arbitrage funds are not as safe as bank FDs but compared to other mutual fund types, it has the potential to provide higher returns at a much lower risk. 

Why is there investor interest in this category?

Investors like arbitrage funds more because from the taxation point of view arbitrage funds are treated as equity funds. Investor’s interest has been shifted to this category after a long term when debt funds were increased from one to three years. Since arbitrage funds maintain an average exposure of more than 65 percent to equity, they are treated as equity funds, their holding period for long-term capital gain is one year. From April 2018, long-term capital gain from equity is taxed at 10 percent. 

Are arbitrage funds safe for investors?

That depends on your investment’s tenure, your liquidity requirements, your risk appetite, and your tax status. If you’re investing for a few days/weeks, liquid funds are better as they are the least volatile among all mutual funds and provide quick and easy liquidity with no exit load. If you’re investing for a few months or over a year and fall in the 20% or 30% tax bracket, you can consider arbitrage funds as they will give you more tax efficiency. However, investing in arbitrage funds entails a small risk to your capital and a moderate risk to your returns. So be prepared for that before investing in these funds.

What returns can an investor expect from this category of arbitrage funds?

Returns from arbitrage funds depend on arbitrage opportunities available between the spot market and the futures market. Such opportunities are high in bull markets. As the assets under management in this segment increase, all this money will be chasing similar arbitrage opportunities and hence returns could be lower. Over the last year, this category of funds has earned an average return of 6.07 percent. Over three years, investors have earned a return of 5.78 percent. 

 

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