In the declining interest rate regime, it is suggested to park your ideal money in liquid funds instead of the otherwise conventional savings bank account to earn better returns. But for those in the highest tax bracket, arbitrage funds emerges as an even better option that offers better tax-efficient returns. Interest in the funds category is prominent with increasing assets under management under the category.
What are arbitrage bunds and how they provide better returns?
Arbitrage funds do not invest direct in equities and track the price differential in the cash and derivatives market. So, the returns on these are based on arbitrage opportunities at a given point in time. Yield from these funds hovers at around 7% which is at par with returns from ultra short term or liquid funds. Nonetheless it offers a tax advantage, as it is treated as a equity fund for taxation purpose.
Taxation Advantage: If the units in arbitrage funds are sold in the first year of purchase, these have short term capital gains implication of 15%. While long term capital gains are not currently taxed on equity schemes. This taxation proves faourable in comparison to liquid funds which are treated as debt schemes for the purpose of taxation with units if sold before three years of investment attracting short term capital gains implications which is charged based on the individual's income tax slab rate. Else if sold after a period of three years, long term capital gains implications arises @ 20% with indexation benefit.
As per the claims of experts, arbitrage funds succeed in offering 40% additional returns as the post tax returns of liquid funds comes at around 5%.
Volatility: Also, the volatility hit stock markets also augur well for this class of funds as the fund manager spots the price differential in the cash and derivatives market.