Should investors consider arbitrage funds in their portfolio? Simply Save

Arbitrage schemes, a hybrid fund category, received net inflows of Rs 59,000 crore during 2023, which is highest among all fund categories, according to the Association of Mutual Funds of India (AMFI), the industry trade body for mutual funds.

In terms of returns, the average of the arbitrage funds category stands at 7.19 percent on a one-year basis. So, what’s behind the bumper inflows to these funds?

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Arbitrage funds allocate a minimum of 65 percent of their assets in equity and equity-related instruments through spot-futures arbitrage.

These funds buy a stock in the cash market and simultaneously sell it in the futures market at a higher price to generate returns from the difference in the prices of the security in the two markets.

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What fuelled the inflows to these funds last year? Do these funds make sense this year? Will they continue to deliver good returns? Moneycontrol spoke to Kirtan Shah, founder of Credence Wealth Advisors, for answers.

Here are the key points from the conversation with Shah:

-     In arbitrage funds, one can expect volatility and returns like a debt fund, but tax treatment is similar to that of equity funds.

-     If you hold this fund for less than a year, you pay 15 percent tax on your capital gains, and 10 percent if you hold it for more than a year.

-     Whenever interest rates are high, the spread between cash and futures is generally higher. That's when arbitrage funds tend to do better.

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-     That’s why a lot of sophisticated money, instead of wanting to stay on the liquid fund side, came into arbitrage funds in 2023.

-     One needs to have at least more than a quarter or up to two quarters of investment horizon in arbitrage funds.

-     Returns depend on the interest rates in the market. If interest rates are higher, one can expect 6 percent kind of returns, but if interest rates are lower, expect around 5 percent or 5.5 percent returns.

-     If more players or more funds come into arbitrage funds, then the extent of arbitrage opportunity shrinks.

-     Investors should have slightly lower return expectations now compared to what arbitrage funds delivered over the last 12-18 months.

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-     With interest rates topping and probably falling in future, a lot of sophisticated money might now start chasing medium-duration and long-duration funds on the fixed income side.

-     Arbitrage fund is only meant for maintaining liquidity.

-     Retail investors in the 30 percent tax bracket can consider parking their liquid portfolio in arbitrage funds.

-     One shouldn’t ideally go with a fund with big assets under management (AUM) because such schemes can find it difficult to monetise the arbitrage opportunity because of their size.