Arbitrage Funds: Should you consider it now?
Volatility seems to be a norm in the current market condition rather than an exception. There are specific categories of funds that come out of hibernation and catch the fancy of investors at this juncture. One such category is arbitrage funds. These are considered an ideal way to navigate the current volatility in the stock market. Even the numbers are on the side of these ‘arbitrage funds’.
Analysis of last one year of returns shows that arbitrage funds have beaten their other hybrid funds with a huge margin. In last one year, Arbitrage funds have generated a return of 5.96 per cent compared to balanced hybrid funds of negative 2.38 per cent. One of the reasons they generate better returns is because of the lower expense ratio. They have the lowest expense ratio currently among all the hybrid funds.
| Categories | Average of Expense Ratio (%) | Average of 1-Year Return (%) | Number of 1-Year Return (%) |
| Hybrid Aggressive | 1.80 | -3.27 | 78.00 |
| Arbitrage | 0.66 | 5.96 | 40.00 |
| Hybrid Balanced | 1.60 | -2.38 | 20.00 |
| Hybrid Conservative | 1.63 | 0.58 | 76.00 |
| Equity Savings | 1.51 | 0.74 | 38.00 |
To understand why arbitrage funds work during volatile times, you need to understand their functioning. Arbitrage Funds work on the mispricing of equity shares in the spot and futures market. The fund manager simultaneously buys shares in the cash market and sells it in futures or derivatives market. The difference in the cost price and the selling price is the return you earn. Volatile time creates lots of such opportunities where mispricing of instruments happens. Arbitrage funds become a safe option for the risk-averse individuals to park their surplus money when there is a persistent fluctuation in the market.
Another important aspect of the arbitrage funds is that they are treated as ‘equity’ funds, which have a better rate than debt funds. Since arbitrage funds maintain an average exposure of more than 65 per cent to equity, they are treated as equity funds. If you stay invested in them for a period of up to 1 year, you make short-term capital gains (STCG) which are taxable. STCG are taxed at the rate of 15 per cent. If you stay invested in them for a period of more than 1 year, the gains will be treated as long-term capital gains (LTCG). LTCG in excess of Rs.1 lakh is taxed at the rate of 10 per cent without the benefit of indexation.