MF Query Board

Readers are requested to send only one query at a time so that more readers get a chance. Have questions relating to any aspect of personal finance. Ask DSIJ at editorial@DSIJ.in and get your queries resolved 

What are arbitrage funds? What should be the horizon to invest in them? Please suggest some good arbitrage funds.
- Nitin Ghule

Arbitrage funds are hybrid mutual fund schemes which aim to profit by taking advantage of the price differences of the same underlying assets in different capital market segments. These funds can invest in debt and money market instruments. As per SEBI’s directive, arbitrage funds must invest at least 65 per cent of their assets in equity and equity-related securities, as for example, stock futures, index futures, etc. These mutual fund schemes have a low risk profile. Since 65 per cent of the assets of these funds are invested in equity and equity-related securities, they are taxed as per equity mutual funds rules.

As such, the long-term capital gains (LTCG) are taxed at 10 per cent without indexation whereas the short-term capital gains (STCG) are taxed at 15 per cent without indexation. Arbitrage is simultaneous buying and selling the same underlying security in different market segments to make risk-free profits. If the price of a security is different in different markets or stock exchanges, an investor can generate risk-free profits by buying the security in the market where the price is lower and simultaneously selling it in the market where the price is higher. It is important that both the buy and sell transactions are executed simultaneously so that you are not exposed to price movement risk.

Since arbitrageurs aim to make risk-free profits, the buy and sell positions are totally hedged. Even though these funds sound safe, there is a downside risk to these funds. Arbitrage funds can invest up to 35 per cent of their assets in debt or money market instruments which also carry credit risks. Hence, it is important to check the credit quality of the debt portion of arbitrage funds. Arbitrage funds are very susceptible to market conditions. For example, in extremely bear markets, the stock futures may trade at a discount to cash prices. Since short selling is not allowed in India, arbitrage is difficult in extremely bearish conditions.

Since cash and futures positions in arbitrage funds are marked to market, there may be times when the net asset value (NAV) of these funds can fall sharply. Investors need to have sufficiently long investment horizons like at least one month for arbitrage fund. Investors who want higher returns compared to savings bank on their short-term funds along with very low risk for their investment can opt for arbitrage funds. Investors in higher tax brackets who want to take advantage of equity taxation and have investment tenure of at least three months or longer can invest their money in these funds. Following are some of the best performing arbitrage funds:

I am a 31-year-old doctor with a moderate to high risk appetite. I want to create a corpus of ₹1 crore in 15 years. I can invest ₹30,000 each month. Kindly suggest how to invest. Should I invest ₹10,000 in three largecap or flexi funds or ₹5,000 in six funds or ₹30,000 in a single fund?
- Vishwas Agarwal

The three points that every investor should keep in mind while investing should be: goals, investment horizon and risk profile. As you wish to invest for a long term goal, you can invest in equity mutual funds which invest in equity stocks. Also, you will have to choose the mutual fund category very wisely as you have mentioned that your risk appetite is moderate to high. It becomes vague to suggest in this scenario. You can, however, find out your exact risk profile by using various tools available online to assess your risk in the form of quizzes, questionnaires, etc. and choose a scheme accordingly. Secondly, you can assign a fixed percentage of your investments to these risky assets, as for example, 20 -25 per cent of your total investment portfolio and then stick to the plan.

As someone who is very new to the mutual fund investment world, we believe that you should not invest in risky schemes like sector schemes or