Arbitrage fund takes advantage of the mispricing between two markets thus hedging against risk. The returns generated by arbitrage funds are not too high but it is the risk-free nature. According to financial expert Rajiv Geol, investors looking for consistent and dependable wealth creation, may select this class of fund for investing.
This is the most hated bull market ever as indexes surge to highs but personal portfolios stay negative. Investors have been grappling with uncertainty as this market continues to frustrate with its volatility. At the same time heightened volatility increases the opportunities for arbitrage which exists as a result of market inefficiencies.
So if you are an investor who can take moderate to low amount of risk, Arbitrage Funds could serve you in this regard since they are these are capable of capitalising such inefficiencies while staying market direction neutral i.e. such funds are neither long nor short on the market.
An arbitrage fund follows a strategy of buying and selling similar and equal securities simultaneously from at least two different markets. It takes advantage of the mispricing between two markets thus hedging against risk. The profit would be the difference between the prices of the instrument in different markets and these days most fund houses have specialized software to capture these opportunities.
But this is not where the meat lies, the real attraction of arbitrage funds is in post-tax returns.
Arbitrage funds enjoy an edge over debt funds mainly because of the tax benefit. No tax on the gains of arbitrage funds in the long term (one year or more) and only 15% tax in short term (less than a year). The mandatory 65% in equity needs to be maintained by the fund manager. Otherwise, they would not qualify for the equity tax benefits. Assuming that returns from arbitrage funds are the same as debt funds or even if arbitrage funds offer a slightly lower return, the tax advantage gives arbitrage funds a significant edge over their debt fund counterparts. The ideal time horizon for investing in these funds is one year or more to avail the tax advantage.
The returns generated by arbitrage funds are not too high but it is the risk-free nature that is their selling point. If you are looking for consistent and dependable wealth creation, you may prefer to graze in these pastures.
(The author is the CEO Bombay Capital Services)