Many investment experts believe leveraging arbitrage opportunities is the best money-making method. Arbitrage means finding a price difference of identical securities in two or more markets and exploiting it. As an investor, if you find that the price of a stock differs in futures and spot markets, you can take advantage of it. But it takes a lot of research and understanding about the market’s operation.
However, not all investors have the time or knowledge to research. Let’s read about arbitrage funds and look at the different features and aspects you need to know before investing in them.
What are Arbitrage Funds?
Arbitrage Funds are equity-oriented hybrid funds that take advantage of arbitrage opportunities on the market. This may be a price mismatch between two exchanges, different prices in the spot and futures market, etc. At the same time, the Arbitrage Fund manager buys and sells the shares and tries to earn a possible return on the difference between the selling and purchase prices of the shares.
It’s fundamentally different from any other form of investment. Here, you buy an asset and wait for its value to rise before selling it. Arbitrage funds trigger taxation of equity mutual funds if no more than 65% of the corpus is invested in equities & equity-related securities. For example, if an investor is in the higher tax bracket (ex-30%), it can lower their taxes. The fund will invest in short-term money market instruments and debt securities when arbitrage opportunities are unavailable. The price differences are usually relatively small.
Who Should Invest in Arbitrage Funds?
Arbitrage funds have the same risk profiles as debt funds. Various arbitrage funds use the Liquid Fund Index as a benchmark for their fund. Arbitrage funds may be ideal for investors who want to invest in equity but do not wish to take any risks. Many investors unwilling to take risks may park their money in an arbitrage fund and make seemingly reasonable returns in a volatile market.
Factors to Consider Before Investing in Arbitrage Funds
Before investing in arbitrage funds in India, you must consider the following key aspects.
- The role of a fund manager
The fund manager identifies and uses arbitrage opportunities to reach the scheme’s investment objective. In addition, he allocates a small proportion of his assets to fixed-income securities with high credit quality. Even when arbitrage opportunities are scarce, he can maintain stable returns.
- Expense Ratio
The fee charged by the fund house to provide fund management services shall be the expense ratio, which shall be a percentage of the fund’s total assets. There’s trading going on every day at an arbitrage fund. Thus, the cost of transactions can be enormous. In addition, if you redeem your units within 30 or 60 days of purchasing them, many arbitrage schemes will impose an exit fee.
- Risks and Returns
Since the fund manager buys and sells stocks on one market simultaneously, there is no risk of equity exposure. But there are few such opportunities, and the price gap needs to be more profound. Therefore, the returns are on average. You may possibly expect a return of about 8% if you remain invested for five to eight years. However, remember that there is no guarantee of returns in arbitrage funds.
Taxation on Arbitrage Fund
The taxation of arbitrage funds is identical to that of equity funds.
- Tax on short-term capital gains (STCG)
If you sell your units of arbitrage mutual funds before the entire year, the capital gain will be considered an STCG (short-term capital gain). A 15% tax will be applied to STCG.
- Long-term capital gain (LTCG) tax
The capital gain on selling your arbitrage mutual fund units will be considered long-term capital gain (LTCG) if you sell them after a year. Up to Rs. 1 lac in LTCGs will be exempt during the fiscal year. Any incremental LTCG over one lakh in a financial year, without indexation benefit, is subject to a 10% tax.
Benefits of Arbitrage Funds
The advantages of these hybrid mutual funds are shown below.
- Arbitrage funds have a low risk relative to other equity funds. Moreover, arbitrage fund investors may possibly receive virtually risk-free returns when the prices of both markets converge.
- Arbitrage funds may exploit high market volatility because they depend on price differentials for possible returns In contrast, other equity and debt investments in the same situation have performed poorly.
To sum it up, arbitrage funds are a type of hybrid fund that uses an arbitrage strategy to get a possible return at low risk. This investment option is open to conservative investors with an investment horizon of at least three months. Moreover, people with a higher tax bracket benefit from taxation advantages by investing in these hybrid funds. To invest in arbitrage funds safely, check out the ELSS app. This app will help you to easily invest in mutual funds. The app offers an intuitive interface that makes it easy to invest in a variety of funds.
Note: Views and opinions contained herein are for information purposes only and should not be construed as investment advice/ recommendation to any party or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The recipient should exercise due caution and/ or seek professional advice before making any decision or entering into any financial obligation based on information, statement or opinion which is expressed herein.
Statutory Disclaimer: Axis Mutual Fund has been established as a Trust under the Indian Trusts Act, 1882, sponsored by Axis Bank Ltd. (liability restricted to Rs. 1 Lakh). Trustee: Axis Mutual Fund Trustee Ltd. Investment Manager: Axis Asset Management Co. Ltd. (the AMC). Risk Factors: Axis Bank Limited is not liable or responsible for any loss or shortfall resulting from the operation of the scheme. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The AMC reserves the right to make modifications and alterations to this statement as may be required from time to time.
Past performance may or may not be sustained in future.
Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.