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Investing in Arbitrage Funds? Know the pros and cons

With the market being highly volatile, investors can opt for Arbitrage funds which are relatively more tax efficient in the short period of typically less than one year.

    1. What are arbitrage funds?

      Arbitrage funds leverage the difference between the price of a basket of shares in the spot and futures market. This is done by investing in equity shares in the cash segment and selling stock futures in the derivatives segment. This is continued till the time the stock future commands a premium. In this way, the fund is not exposed to any particular share or to the vagaries of an index. Every purchase transaction is covered by going short in the derivatives market. These opportunities are concentrated in the short term. This reduces the volatility that the fund is exposed to since there are no long-term cyclical features in play. Arbitrage funds have a risk profile similar to a debt fund. When comparing returns, many funds use Nifty 50 Arbitrage index as a benchmark.


    2. What draws investors to arbitrage funds?

      Investors prefer arbitrage funds because it provides returns at a lower risk as compared to an equity fund without having a high holding period like a debt fund. A debt fund has to be held for 3 years to get a tax benefit as compared to an equity fund which enjoys a 1 year holding period. Arbitrage funds invest more than 65% of their net assets into equity and equity related securities which classifies them as equity funds. The long-term capital gains on equity are taxed at 10%.


    3. How safe is the arbitrage fund investment strategy?

      By their very investment strategy, arbitrage funds hedge their risks. They are considered quite safe because they cover their positions by taking an exposure in the derivatives segment. This reduces the risk and increases the safety. These funds can work well when markets are uncertain and volatile.

    4. What kind of returns can one expect from these funds?

      As safe as arbitrage funds are, their returns are contingent on the arbitrage opportunities available. This price differential between the cash and derivatives segments is temporary and the fund manager has to be constantly aware to capitalize on existing opportunities. As arbitrage funds grow, the same capital will chase the limited opportunities which means returns can be lower.

      Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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