Arbitrage Mutual Funds

Arbitrage funds, a type of hybrid mutual fund, engage in simultaneous buying and selling of stocks and securities across various markets, presenting a low-risk investment avenue with stable income potential. These funds allocate a minimum of 65% of their investments to equity and equity-related assets, ensuring a balanced approach to generating returns.

Stable performance of funds

Low risk investment

Tax efficient returns on equity

Suitable for a moderate investment horizon

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What are Arbitrage Funds?

Arbitrage funds are a type of mutual fund that aims to generate returns by exploiting the price differences of securities in different markets or forms. They typically buy and sell the same asset in different markets to take advantage of these price discrepancies. This strategy aims to provide relatively low-risk returns compared to other equity investments. Arbitrage funds are suitable for investors seeking stable returns with minimal exposure to market volatility.

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Advantages of Investing in Arbitrage Mutual Funds

Low Risk
Arbitrage mutual funds look to buy equities at a low price and sell them at a high price. As the buying and selling happens immediately, the profits are guaranteed. Fluctuations in the stock market won’t lead to a loss. It will increase or decrease the profits. Thus, arbitrage funds carry much less risk compared to other mutual funds.
Benefit of Volatile Markets
Volatile stock markets can be very good for arbitrage mutual funds. The gap between the stock price and the futures market presents an opportunity for profit maximisation. If the stock market is volatile, the fund manager will have opportunities to buy and sell equities for greater profits. It is one of the few mutual funds which thrives in a volatile market.
Taxed as Equity Funds
In terms of taxation, an equity arbitrage fund gets the same treatment as an equity fund. Depending on the maturity period, short-term or long-term capital gains taxation rules will be applied, that is, 15% and 10% respectively.

Limitations of Investing in Arbitrage Mutual Funds

Limited Growth Potential
Arbitrage mutual funds don’t provide a significantly large return. They are a safe investment best suited for moderate returns. They may be better than bank deposits but other mutual funds can create better results. If the gap between the stock and the futures market decreases, the returns fall further.
Cost of Investment
A good arbitrage fund makes money with a large number of transactions. This leads to an increase in the expense ratio. The exit load can also be fairly high. It can cut down the arbitrage mutual funds returns.
Unpredictability
As arbitrage mutual funds thrive on market volatility, it can be difficult to predict the returns. Moreover, a stable market is not good from the point of view of profitability.

Who Should Invest in Arbitrage Mutual Funds?

Minimal Risk Takers
Are you scared of market risks? Then you can invest in arbitrage mutual funds. Though these funds benefit from market volatility, the investors are not hurt by it. Thus an investor can park their money in it for 3-5 years to get reasonable returns.
Confident with Volatile Markets
An investor always looks at the market conditions while making investment decisions. In most cases, volatile markets are not preferable. But the good thing about arbitrage mutual funds is that they thrive exactly in such situations. If you think the markets are volatile, then maybe you can put some money in an arbitrage fund.
Having Short to Medium Investment Horizon
Arbitrage mutual fund returns are good if you want to invest for at least a few years. In case you have a moderate investment horizon, that is for 3 to 7 years and get stable returns, then this mutual fund will be a feasible option.

Taxation Rules of Arbitrage Mutual Funds

Short-Term Capital Gains (STCG)
Gains from arbitrage mutual funds held for less than 12 months are classified as short-term capital gains and are taxed at 15%.
Long-Term Capital Gains (LTCG)
Gains from arbitrage mutual funds held for more than 12 months are classified as long-term capital gains and are taxed at 10% without the benefit of indexation.

Frequently Asked Questions

Arbitrage funds involve the simultaneous purchases and sales of an asset in two distinctive markets to profit from the difference in prices.

S.no	Fund Name	5 Year Returns (Annualized)
1	Tata Arbitrage Fund Direct - Growth	6.18%
2	Invesco India Arbitrage Fund Direct-Growth	6.15%
3	Kotak Equity Arbitrage Fund Direct-Growth	6.14%
4	Edelweiss Arbitrage Fund Direct-Growth	6.07%
5	Nippon India Arbitrage Fund Direct-Growth	5.99%

Arbitrage mutual funds typically offer moderate returns of around 4% to 7% annually with relatively low risk, exploiting price differences in cash and futures markets. They are also tax-efficient, often treated similarly to equity funds for taxation purposes.

The typical holding period for arbitrage mutual funds is short to medium term, usually ranging from a few months to a year, to take advantage of short-term price discrepancies.

Arbitrage funds usually come with only a level of risk for the investor since each security is bought and sold at the same time, and there is not much risk involved in it.

They are taxed in the same way as equity funds. Short-term capital gains tax is applicable on holding them for up to 1 year. Long-term capital gains tax is applicable for holding them for more than 1 year.

Some of the factors worth considering are: