What are Arbitrage funds?

Updated: Friday, December 13, 2013, 12:36 [IST]

Arbitrage funds is a mutual fund category that capitalizes on the difference in price in the cash and derivatives market for generating returns. The degree of volatility of the underlying asset determines returns from these type of mutual funds. With the provision to invest a substantial proportion in debt markets, such funds are considered to be hybrid in nature.

Factors that drive high returns from arbitrage funds

Volatility: An increase in volatility in stock markets (measured by Volatility Index or VIX) favours arbitrage funds as high degree of volatility provides greater arbitrage opportunities. In the last one year, owing to several global and domestic economic and geo-political factors, Indian stock market witnessed high volatility and going ahead the trend is expected to continue thanks to stimulus tapering decision of the Federal Reserve and general elections next year.

Interest rate: Uptrend in interest rate in the economy also holds good for arbitrage funds as more arbitrage opportunities are provided in such an environment.

Tax Implications

As equities form a major chunk of the portfolio of arbitrage funds, tax implication on such funds is similar to equity funds. However, such funds are more tax-efficient in comparison to other equity funds. In case such funds are held for a year's time, returns from the fund are tax-exempt. In a case, when the funds are held only for six months, no exit load is charged and short term capital gain @ 15% is to be paid. A number of arbitrage funds even offer dividends that do not attract tax liability.

Who should invest in arbitrage mutual funds?

Such mutual funds prove to be a suitable bet for investors with low risk appetite. In an environment of continuous high volatility in the stock markets such funds leverage market inefficiencies in the equity and derivatives market and make profits for the investors.

Further, as suggested by experts investment in arbitrage funds is apt only for investors with an investment horizon of between six months and a year.

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