Comprehensive Guide on Arbitrage Funds: Investment Strategies Explained
### Title: Understanding Arbitrage Funds: A Low-Risk Investment Strategy for Volatile Markets
Arbitrage funds, a type of equity-oriented mutual fund, have gained popularity among investors seeking stable, low-risk returns. These funds operate by exploiting price differences between the cash (spot) and futures markets of the same security.
Arbitrage fund managers buy a stock in the cash market and sell it in the futures market, capturing the spread between the two prices. This strategy allows them to generate returns with minimal exposure to market volatility, as their profits are not dependent on the direction of market movements.
In comparison, liquid funds, which invest in short-term debt securities, offer returns similar to or slightly above those of traditional fixed deposits. However, they may be less stable in terms of returns consistency due to interest rate fluctuations. Liquid funds are ideal for short-term cash management, especially when funds are needed within a month.
Arbitrage funds, on the other hand, are more suitable for a 6-month to 2-year horizon. They offer returns in the range of 7-8% per annum, which can be higher than traditional fixed deposits and comparable or slightly better than some liquid funds.
Risk-wise, arbitrage funds are considered low-risk because they aim to lock in profits from price differences rather than relying on market direction. They are less volatile than traditional equity funds. Liquid funds, while also considered low-risk, may be less stable in terms of returns consistency due to interest rate fluctuations.
Tax efficiency is another advantage of arbitrage funds. Since they are equity-oriented, they benefit from equity tax treatment if they hold at least 65% of their portfolio in equity. This means long-term capital gains (LTCG) are taxed at 10% if exceeding ₹1 lakh, which is more favourable than debt funds. Liquid funds, classified as debt funds, are taxed as per the income tax slab if sold within three years. If held for more than three years, LTCG is taxed at 20% with indexation, which can be less efficient than equity-oriented funds.
In terms of liquidity, both arbitrage funds and liquid funds offer high liquidity, with investments typically being redeemable within a few days for arbitrage funds and often allowing same-day or next-day redemption for liquid funds.
Historically, returns from arbitrage funds have been comparable to liquid funds, but slightly higher. It is important to note that the more price differences exist, the more arbitrage opportunities arise, making these funds perform well in volatile markets.
Investors looking for short- to medium-term investments with tax efficiency and a way to earn decent returns in volatile markets will find arbitrage funds attractive. However, always check the expense ratio of arbitrage funds, as high costs can impact returns.
- For individuals seeking investment opportunities in the realm of personal-finance, both arbitrage funds and mutual funds such as debt funds and equity funds provide avenues for investment.
- When considering low-risk investment strategies, arbitrage funds and liquid funds, which invest in short-term debt securities, might be favorable choices for those looking to capitalize on markets without high market volatility.
- Arbitrage funds, a type of mutual fund, and liquid funds are not only low-risk investment options but also efficient in terms of fiscal responsibilities. Arbitrage funds benefit from equity tax treatment, offering more favorable long-term capital gains tax compared to liquid funds, which are classified as debt funds.
