The working of Arbitrage Mutual Funds in India

If you look for a short-term investment plan with low-risk, you may choose liquid funds for parking your money. But if you consider tax benefits also along with returns, then the best option is arbitrage funds. Many tax-conscious investors choose arbitrage mutual funds to invest their short-term money as it taxed at low rates. Apart from better tax efficiency, these funds are a good substitute for short-term debt funds. Being a low-risk investment, arbitrage funds are suitable for risk-averse investors who look for equity-oriented investment choices.  These funds are more tax-efficient and at the same, provide better returns than liquid funds. This article explains what arbitrage funds are and how they work.

What are Arbitrage funds?

Everybody looks for opportunities to make profits without risks, and you can make risk-free profits by investing in arbitrage funds. These are a type of mutual funds that leverages the arbitrage opportunities that arise due to the inefficiencies in the spot and the derivatives markets.  The arbitrage opportunities can arise in the market due to various reasons, like different pricing in the spot and futures market and pricing mismatch between two exchanges. If you are a smart investor, you can take advantage of such opportunities to make gains with no risk or minimal risk by investing in arbitrage funds. These are equity-oriented hybrid funds that have a unique working method to make profits, which make it different from other mutual fund instruments. In arbitrage funds, the fund managers buy and sell the shares simultaneously, and the difference between the selling and buying price is what they earn.

How arbitrage funds work?

As mentioned above, buying and selling the same security straight away on different markets is the method to make profits in arbitrage funds. Two markets where the trades of arbitrage funds occurred heavily are the cash (stock) and the futures market. The gains from these funds are calculated based on the difference in pricing of the stock between the cash and the futures market. Some transaction costs are also considered while calculating the gains in arbitrage funds such as the brokerage payments, service tax, and securities transaction tax (STT). The fund managers execute an arbitrage trade only when the price difference between the spot markets and futures markets are sufficient enough to cover all such transaction costs.

The price difference between the spot markets and futures markets creates arbitrage opportunities. In order to calculate the gains, the fund managers assess the mismatch between the prices in the spot market and futures market on an unbiased basis. They will buy the stock in the spot market if the price of a stock in the futures market is higher after adjusting the transaction costs and taxes and sell the same in the futures market simultaneously. The difference in the selling and buying prices is the gains from such trades. Like the price difference in the spot and futures market provides arbitrage opportunities, the difference in the prices of shares between different stock exchanges also provides such opportunities.

Arbitrage funds are a good choice for investors who prefer low-risk investment options. These funds are a safe avenue for investors to park their money, especially in a situation of continuing volatility. These funds can generate profits for investors by taking advantage of market inefficiencies. Since these funds mainly investing in equities, the tax treatment of arbitrage funds is similar to equity funds. Choose arbitrage funds if you look for a great option to park your hard-earned money for the short-term.

That’s why Comparte Investment team asks do you have “Nivesh Ki Aadat”.

With this one can say “Mutual Fund Sahi hai”, so let me do Nivesh