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What is Arbitrage Fund - Risks, Benefits, and How They Work
Arbitrage funds are a type of investment strategy. I.e., the funds generate income by simultaneously buying and selling securities in various markets for different prices. As exploiting the price differences between the spot market and futures markets, arbitrage funds are often considered a low-risk investment method. Besides, these funds typically invest a portion of their assets in debt securities, which are relatively less risky than equity securities. Thus, arbitrage mutual funds are suitable for investors looking for low-risk and stable returns in volatile markets. They can also help diversify the portfolio and reduce the overall risk. Moreover, despite functioning as a hybrid fund by investing in both equity and debt, arbitrage funds fall under the equity category. This categorization allows investors to access more tax-efficient returns, making it a more investment-friendly option. Let’s scroll down to learn more on what is Arbitrage.
List of the Top Arbitrage Mutual Funds in India
Fund Name | Net Asset Value (NAV) | Assets under management (AUM) |
Kotak Equity Arbitrage Fund | ₹ 33.314 | ₹ 27,412.05 Cr |
Invesco India Arbitrage | ₹ 28.431 | ₹ 8,155.52 Cr |
SBI Arbitrage Opportunities Fund | ₹ 30.128 | ₹ 21,238.04 Cr |
Edelweiss Arbitrage Fund | ₹ 17.269 | ₹ 7,035.52 Cr |
ICICI Prudential Arbitrage Fund | ₹ 30.571 | ₹ 15,356.15 Cr |
Nippon India Arbitrage Fund | ₹ 23.691 | ₹ 11,326.42 Cr |
UTI Arbitrage Fund | ₹ 31.514 | ₹ 3,773.06 Cr |
Tata Arbitrage Fund | ₹ 12.816 | ₹ 7,682.14 Cr |
Bandhan Arbitrage Fund | ₹ 28.951 | ₹ 4,096.11 Cr |
DSP Arbitrage Fund | ₹ 13.344 | ₹ 2,613.55 Cr |
Aditya Birla Sunlife Arbitrage Fund | ₹ 23.69 | ₹ 5,923.24 Cr |
Mirae Asset Arbitrage Fund | ₹ 11.645 | ₹ 529.38 Cr |
How Do Arbitrage Funds Work?
Simply put, arbitrage funds make money by finding and using the differences in prices of the same thing in different places. In other words, they buy and sell the same securities simultaneously in different markets, such as the spot and futures market, and earn profits from the price difference. For example, suppose a company’s share sells for Rs 100 in one market and Rs 105 in another. An arbitrage fund can buy the share for Rs 100 and sell it for Rs 105 at the same time, and earn Rs 5 as profit. By doing so, the fund does not have to worry about the ups and downs of the market and can earn steady returns.
What Are The Risks in Arbitrage Funds?
Although arbitrage funds are relatively low-risk, they can’t be entirely risk-free. Some of the major risks associated with arbitrage funds are as follows:
Expense Ratio Risk
Arbitrage funds have high expense ratios, as they involve frequent trading and transaction costs. A high expense ratio may reduce the net returns of the fund and affect its attractiveness to investors.
Liquidity Risk
Arbitrage funds may face liquidity issues, which may hamper their ability to execute trades quickly and efficiently. Namely, a lack of liquidity may widen the bid-ask spread, increase the transaction costs, or delay the settlement of the trades. Further, it affects the fund’s performance and returns.
Interest Rate Risk
Arbitrage funds are affected by interest rate changes, which may impact the valuation and liquidity of the debt securities in their portfolio. A rise in interest rates may reduce the value and demand of the debt securities, resulting in lower returns or capital erosion for the fund.
Credit Risk
Arbitrage mutual funds are exposed to credit risk, which is the risk of default or downgrade of the issuers of the debt securities in their portfolio. A default or downgrade may cause a loss of principal or interest income for the fund or affect its ability to sell the securities at a favorable price.
Market Risk
Arbitrage funds generate better returns in more volatile market conditions and less returns in stable markets. Consequently, if the price gap between cash and futures markets shrinks or vanishes, the fund would possibly struggle to produce positive returns or even face losses.
Top Returns in Arbitrage Funds
The returns of arbitrage mutual funds depend on the availability and profitability of arbitrage opportunities in the market, which may vary depending on the market conditions and liquidity. Historically, average annual returns for arbitrage funds have varied between 5% and 8%, contingent on the fund’s performance and strategy. Now, let’s examine the returns of top-performing arbitrage funds in India:
Fund Name | 1-year Returns | 2-year Returns | 3-year Returns | 5-year Returns | 10-year Returns |
Kotak Equity Arbitrage Fund | 7.66% | 11.82% | 16.35% | 29.09% | 82.79% |
Invesco India Arbitrage | 7.59% | 12.39% | 16.41% | 28.72% | 79.27% |
SBI Arbitrage Opportunities Fund | 7.76% | 11.92% | 16.42% | 28.11% | 78.90% |
Edelweiss Arbitrage Fund | 7.42% | 11.42% | 15.80% | 28.84% | Not yet reached 10-year |
ICICI Prudential Arbitrage Fund | 7.40% | 11.22% | 15.62% | 28.02% | 80.04% |
Nippon India Arbitrage Fund | 7.30% | 11.11% | 15.44 | 28.16% | 79.50% |
UTI Arbitrage Fund | 7.41% | 11.07% | 15.46% | 28.27% | 79.01% |
Tata Arbitrage Fund | 7.29% | 10.96% | 15.30% | Not yet reached 5-years. | Not yet reached 10-year |
Bandhan Arbitrage Fund | 7.38% | 11.10% | 15.15% | 27.24% | 78.00% |
DSP Arbitrage Fund | 7.42% | 11.07% | 14.98% | 27.62% | Not yet reached 10-year |
Aditya Birla Sunlife Arbitrage Fund | 7.30% | 10.97% | 15.26% | 27.74% | 77.76% |
Mirae Asset Arbitrage Fund | 7.30% | 10.96% | 15.10% | Not yet reached 5-year | Not yet reached 10-year |
Which is Better: Arbitrage or Liquid?
There is no definitive answer to which one is better, as it depends on your investment goals, risk appetite, time horizon, and tax implications. However, some factors you should consider while comparing arbitrage and liquid funds are as follows:
Returns
Arbitrage mutual funds may generate relatively higher returns than liquid funds in a volatile market, while liquid funds tend to be relatively stable and consistent when generating returns for investors. As per the historical data, the average annual returns of arbitrage funds have ranged between 5% to 8% p.a., depending on the fund’s performance and strategy. On the other hand, liquid funds have generally delivered returns of around 6% to 7% p.a.
Tax Efficiency
Arbitrage funds are more tax-efficient than liquid funds, as they are treated as equity funds for taxation purposes. Namely, arbitrage funds are taxed at 15% for short-term capital gains (holding period less than 12 months) and 10% for long-term capital gains (holding period more than 12 months) without indexation. Liquid funds are taxed as per the investor’s income tax slab rate, irrespective of the holding period. This differential in taxation makes arbitrage funds more attractive than liquid funds, especially for investors in the higher tax brackets.
Risk
Liquid funds are considered more secure than arbitrage funds because they often invest money in debt-related instruments. Arbitrage funds pose relatively more risk as their returns hinge on market volatility. Namely, arbitrage funds locate ample possibilities in a bullish marketplace but can also encounter challenges in stable conditions.
Suitability
Arbitrage funds suit people looking for low-risk and stable returns in volatile markets. They also can help diversify the portfolio and decrease the overall risk as well. At the same time, liquid funds are appropriate for those who looking for liquidity and more safety. Liquid funds are further considered best to develop an emergency fund or save for a particular intention because they are easily accessible.
Who Should Consider Arbitrage Mutual Funds?
The following types of investors may find Arbitrage funds ideal:
Risk-Averse Investors
Individuals who seek low-risk investment options like debt funds but with little equity exposure.
Short-term Investors
Individuals who seek a short to medium-term investment horizon find Arbitrage funds ideal.
Moderate Return Seekers
Individuals who seek returns beyond what traditional bank savings or debt investments provide, yet aim to avoid the high fluctuations associated with equity markets.
Considerations Before Investing in Arbitrage Mutual Funds
Before investing in arbitrage mutual funds in India, it is important to consider the following factors:
Risks
Arbitrage funds generally carry a lower risk in comparison to equity funds. This is due to the fact the fund sells the shares as quickly as it buys them, often at a better price. However, this does not mean arbitrage funds are hazard-free. The fund only can earn a better profit when the market is more turbulent, while a stable market condition can hinder predicted returns. Hence, before choosing Arbitrage finances, be organised for a certain stage of risk, albeit quite slightly as compared to equity funds.
Return
The typical return for Arbitrage mutual funds ranges from 5% to 8% p.a., which is lower compared to equity mutual funds. Arbitrage funds are perfect for one who looking for a return below 8% p.a. However, it’s recommended that you make certain that your chosen arbitrage funds deliver a minimum return somewhere between 5% and 6% p.a.
Fund Manager
A professional and experienced fund manager can generate regular and stable returns for investors. On the other hand, an amateur or inefficient fund supervisor might also miss out on profitable trades or incur losses. Hence, it’s advisable to check the fund manager’s profile well enough before finalising your decision.
Expense Ratio
Arbitrage funds normally have excessive fee ratios related to other types of mutual funds. The average price ratio of arbitrage funds in India is around 0.4%. This is higher than the equity funds, which is around 0.2%. Therefore, evaluating the expense ratios of various arbitrage funds and choosing the cost-effective fund is beneficial.
Investment Horizon
Investment horizon refers to the duration of your investment. Arbitrage funds are commonly considered ideal for a short-term period, between 3 and 5 years. Moreover, as its performance highly depends on the volatile market conditions, investing a lump sum at the opportune moment is preferable.
Related Resource |
What is an Exit Load? |
XIRR in Mutual Funds |
Net Asset Value |
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What is Arbitrage Fund
Arbitrage funds are a type of investment strategy. I.e., the funds generate income by simultaneously buying and selling securities in various markets for different prices. As exploiting the price differences between the