Stock market investing can be unpredictable. In this, arbitrage mutual funds offer a more stable way to invest. They provide a market-neutral strategy, appealing to investors who want low-risk, consistent returns. Let’s explore how arbitrage mutual funds operate in volatile markets and why they are often seen as a safe option.
What Are Arbitrage Mutual Funds?
Arbitrage funds are hybrid mutual funds that exploit the price differentials in different markets to generate returns. It implies buying and selling the same or similar security in different markets, during the same periods and cash-in the profit from the difference.
There are two main markets involved: cash (spot) and futures. In the cash market, shares are bought and sold promptly at the current price. In the futures market, you engage in an agreement to buy or sell an underlying security at a certain price on a predetermined future date.
Fund managers buy stocks at a lower price in the cash market and simultaneously sell them at a higher price in the futures market. This price gap, or arbitrage opportunity, allows investors to earn returns with minimal exposure to market risk.
Arbitrage mutual funds in India have performed steadily over the past few years.
- According to recent data from FY24, top-performing arbitrage mutual funds have delivered YTD returns between 6-7%% annually, providing a secure alternative to both debt and equity funds.
- During the market volatility, arbitrage mutual funds continued to perform well, proving their resilience. HDFC Arbitrage Fund, for example, delivered a 6.55% return in FY24, while Kotak Equity Arbitrage Fund posted 6.76% over the same period.
Why Choose Arbitrage Mutual Funds?
Arbitrage mutual funds are ideal for risk-averse investors. If you’re looking for stability during market volatility or need an investment for the short to medium term, these funds are worth considering.
These funds also serve well for investors seeking tax efficiency, as they qualify for equity taxation benefits. The relatively low risk associated with these funds makes them a better choice for those who wish to avoid the volatility associated with equity investments.
Arbitrage mutual funds offer several advantages for risk-averse investors:
- Low-Risk Exposure: By leveraging market inefficiencies, these funds stay relatively unaffected by market fluctuations.
- Tax Efficiency: Treated as equity funds, long-term capital gains exceeding Rs 1.25 lakh are taxed at 12.50%, while short-term gains are taxed at 20%.
- Consistent Returns: Last year, arbitrage mutual funds generated an average of 8% in annual returns. Though lower than equity funds, they come with significantly less risk.
Key Considerations Before Investing in Arbitrage Mutual Funds
Before investing in arbitrage mutual funds, keep these factors in mind:
- Investment Horizon: These funds are best suited for short to medium-term investors. Ideally, an investment horizon of at least a few years is advisable to benefit fully from arbitrage opportunities.
- Expense Ratio: These funds typically come with slightly higher expense ratios than traditional equity funds, given the active management involved in capitalizing on price differentials. Always check the fund’s expense ratio to ensure it aligns with your expectations.
- Market Liquidity: While arbitrage opportunities are common, they may diminish during periods of low market liquidity, potentially affecting returns.
Conclusion
Arbitrage mutual funds offer a low-risk solution for investors looking to avoid market volatility. By leveraging price differences between cash and futures markets, these funds provide steady returns with minimal exposure to market risks. They are an excellent addition to a balanced investment portfolio, particularly for those focused on market-neutral strategies.
For those considering large investments, a lumpsum calculator can help determine the return potential and the effectiveness of arbitrage mutual funds in their overall portfolio strategy.
