An Arbitrage Fund is a type of investment fund that aims to make money by buying and selling stocks in different markets at the same time, taking advantage of price differences to earn profits. This strategy helps reduce risk and provide steady returns.
Content ID:
- What Is Arbitrage Fund?
- Arbitrage Funds Example
- How Do Arbitrage Funds Work?
- Arbitrage Funds Vs Liquid Funds
- Benefits Of Arbitrage Mutual Funds
- How to Invest in Arbitrage Funds?
- Arbitrage Fund Returns
- Arbitrage Fund – Quick Summary
- Arbitrage Funds India – FAQs
What Is Arbitrage Fund?
An Arbitrage Fund is a mutual fund designed to take advantage of the price differential between two or more markets. By buying in one market and selling in another, these funds aim to generate returns.
Arbitrage Funds primarily seek to exploit pricing inefficiencies in the equity markets without taking on significant risk. They do this by purchasing stocks at a lower price in the cash market and simultaneously selling them at a higher price in the futures or derivatives market, thereby locking in the price difference as profit. This strategy is particularly effective in volatile markets, allowing these funds to offer stable returns with relatively low risk. Arbitrage Funds are suitable for investors looking for safer investment avenues that provide returns slightly higher than traditional savings instruments, making them an attractive option for conservative investors aiming to surpass inflation while minimizing risk.
Arbitrage Funds Example
Suppose an investor uses an Arbitrage Fund to exploit the price difference of ABC Ltd.’s stock, which is trading at INR 100 in the cash market and INR 102 in the futures market.
In this scenario, the fund buys ABC Ltd.’s stock at INR 100 in the cash market and simultaneously sells the same stock in the futures market at INR 102. The INR 2 difference (minus transaction costs) represents the profit from this arbitrage opportunity. Assuming the transaction costs are INR 0.50 per share, the net profit would be INR 1.50 per share.
This example illustrates how Arbitrage Funds work by leveraging the price discrepancies in different markets for the same asset. The fund capitalizes on these differences to generate returns for its investors, minimizing risk by ensuring that the positions are fully hedged. The strategy aims for modest but steady returns, making it an appealing option for conservative investors seeking to outperform traditional fixed-income investments while maintaining a low-risk profile.
How Do Arbitrage Funds Work?
Arbitrage funds work by exploiting price discrepancies between different markets or instruments for the same asset. They aim for risk-free returns by simultaneously buying and selling an asset in different markets.
- Identification of Opportunity: Arbitrage funds constantly monitor price differences between the cash and futures markets for the same security. They use sophisticated technology and algorithms to spot these opportunities quickly and efficiently.
- Simultaneous Transactions: When a price discrepancy is identified, the fund buys the security at a lower price in one market and sells it at a higher price in another market. This strategy is executed almost instantaneously to capitalize on the existing price gap before it closes.
- Locking in Profits: The simultaneous transactions ensure a risk-free profit (minus transaction costs) due to the price difference. These profits, although typically small on a per-share basis, can add up to significant amounts when large volumes are traded.
- Repetition for Gain: This process is repeated whenever suitable arbitrage opportunities arise, contributing to the fund’s earnings. Over time, the consistent accumulation of these small gains can lead to substantial returns for investors, making arbitrage funds a compelling choice for risk-averse individuals.
Arbitrage Funds Vs Liquid Funds
The main difference between Arbitrage Funds and Liquid Funds is that Arbitrage Funds seek to profit from price discrepancies between different markets for the same security, while Liquid Funds invest in short-term debt instruments and money market securities, aiming for liquidity and stability.
| Parameter | Arbitrage Funds | Liquid Funds |
| Objective | To earn returns by exploiting market inefficiencies between cash and futures markets. | To provide liquidity and safety of principal by investing in short-term instruments. |
| Risk | Relatively low risk, depends on the efficiency of arbitrage strategy. | Very low risk, primarily invests in high-quality debt instruments. |
| Returns | Potentially higher than liquid funds due to arbitrage opportunities, but can vary based on market conditions. | Generally offers steady and predictable returns, often slightly above savings account rates. |
| Investment Horizon | Suitable for short to medium-term investment horizons. | Ideal for very short-term investments, usually up to 3 months. |
| Taxation | Treated as equity funds for tax purposes if equity exposure is over 65%; profits taxed accordingly. | Interest income is added to the investor’s total income and taxed according to their income tax slab. |
| Liquidity | Offers reasonable liquidity, but subject to settlement periods of the arbitrage trades. | High liquidity, with investments easily converted to cash usually within one working day. |
| Market Volatility | Can benefit from market volatility, as it provides more arbitrage opportunities. | Almost unaffected by market volatility, focusing on preservation of capital and liquidity. |
Benefits Of Arbitrage Mutual Funds
The primary benefit of Arbitrage Mutual Funds is their ability to provide investors with equity-like returns while maintaining a risk profile similar to debt instruments. This unique blend offers a safer investment avenue during volatile market conditions.
- Low Risk: Arbitrage funds are considered low risk because they exploit price differences between markets, rather than relying on stock performance, which reduces exposure to market volatility.
- Tax Efficiency: For tax purposes, arbitrage funds are often treated as equity funds, making long-term gains (over a year) taxable at 10% without indexation, which is more favorable compared to debt fund taxation.
- Stable Returns: These funds aim to deliver stable returns by capitalizing on arbitrage opportunities that exist irrespective of the market being in a bull or bear phase, making them a reliable investment choice.
- Diversification: Investing in arbitrage funds can help diversify an investor’s portfolio, offering a balance between the high risk of equity funds and the low risk of debt funds.
- Suitable for Short-term Investment: Arbitrage funds are ideal for investors looking to park their money for short to medium terms, offering better liquidity compared to traditional equity investments.
- Inflation-beating Potential: While safer than debt funds, arbitrage funds often provide returns that can keep pace with or exceed inflation, unlike savings accounts or fixed deposits, enhancing the purchasing power of investors over time.
How to Invest in Arbitrage Funds?
Investing in Arbitrage Funds is straightforward and involves a few simple steps. First, investors need to assess their investment goals, risk appetite, and the market conditions to determine if arbitrage funds suit their portfolio.
- Research and Select a Fund: Start by researching various arbitrage funds to find one that aligns with your investment goals. Look at the fund’s past performance, the experience of the fund manager, and the expense ratio.
- Investment Platform: Choose an investment platform. You can invest directly through online platforms like Alice Blue that offer mutual fund investments.
- Complete KYC Procedures: Ensure that your Know Your Customer (KYC) procedures are completed. This is a mandatory step for investing in mutual funds in India and involves submitting identity and address proofs.
- Decide on Investment Amount: Determine how much you want to invest. Some arbitrage funds may have a minimum investment amount, so it’s essential to check this before investing.
- SIP or Lump Sum: Decide whether you want to invest a lump sum amount or opt for a Systematic Investment Plan (SIP), which allows you to invest a fixed amount regularly.
- Monitor Your Investment: After investing, it’s crucial to monitor the performance of your arbitrage fund investment. This includes tracking the returns and comparing them with your investment goals.
Arbitrage Fund Returns
Arbitrage Fund Returns typically offer investors moderate returns, with historical annualized returns averaging around 5.9% over the past three years and 5.75% in the last five years. These returns are generally more stable and less volatile than pure equity funds.
Arbitrage funds aim to capitalize on the price differential between the cash and futures markets, which allows them to generate returns that are often higher than those of a savings account or short-term fixed deposits, making them an attractive option for investors seeking relatively safe and higher returns than traditional low-risk investment avenues.
Comprehensive Overview of Arbitrage Fund Returns
- Performance Against Benchmarks: Arbitrage funds often aim to outperform traditional savings rates and short-term fixed deposit rates, providing investors with a low-risk avenue for better returns. Their performance is usually benchmarked against liquid or ultra-short-term debt funds.
- Influence of Market Volatility: The returns from arbitrage funds can be influenced by the level of market volatility. Higher volatility can lead to more arbitrage opportunities, potentially increasing the returns these funds can offer.
- Taxation Benefits: The tax treatment of arbitrage funds, considered equity funds for holding periods over a year, means long-term capital gains are taxed at 10% without indexation. This can enhance post-tax returns for investors compared to other short-term investment options.
- Comparison with Liquid Funds: While liquid funds may offer slightly lower risk, arbitrage funds typically provide competitive returns with potentially higher yields due to their unique strategy of exploiting market inefficiencies.
- Investment Horizon: The returns from arbitrage funds are more predictable in the short to medium term, making them suitable for investors with an investment horizon of one to three years.
- Risk-Adjusted Returns: Arbitrage funds provide risk-adjusted returns that are attractive to conservative investors. The strategy of buying and selling securities in different markets to exploit price differences helps in mitigating risks while aiming for steady returns.
Arbitrage Fund – Quick Summary
- Arbitrage Funds aim to earn profits by leveraging price differences in stocks across different markets, offering a strategy that reduces risk and provides steady returns.
- These funds exploit pricing inefficiencies in equity markets to generate returns without significant risk, making them suitable for conservative investors seeking safer investment avenues.
- An example of arbitrage involves buying a stock at a lower price in the cash market and selling it at a higher price in the futures market, securing a profit from the price difference.
- The operation of Arbitrage Funds centers on exploiting price discrepancies across markets for the same asset, aiming for risk-free returns through simultaneous buying and selling.
- The primary benefit of Arbitrage Mutual Funds is delivering equity-like returns while maintaining a risk profile akin to debt instruments, offering a safer investment option during market volatility.
- Investing in Arbitrage Funds involves simple steps, including assessing investment goals and market conditions to decide if they fit the investor’s portfolio.
- Arbitrage Fund Returns offer moderate, stable, and less volatile returns compared to pure equity funds, with historical annualized returns around 5.9% over three years and 5.75% over five years, appealing to investors seeking safer and relatively higher returns.
- Invest in mutual funds for free with Alice Blue.
Arbitrage Funds India – FAQs
What Is Arbitrage Fund?
An Arbitrage Fund is a type of mutual fund that aims to generate profit by exploiting the price difference of an asset between two or more markets. It’s a low-risk investment option that offers returns slightly higher than traditional saving methods.
What Is An Example Of Arbitrage?
An example of arbitrage is buying a stock at INR 100 in the cash market and simultaneously selling it at INR 102 in the futures market, thus securing a risk-free profit of INR 2 per share due to price difference.
How To Invest In Arbitrage Funds?
To invest in arbitrage funds, complete your KYC formalities, research and select a suitable arbitrage fund, decide on the investment amount, and choose between a lump sum or SIP investment through an online platform or offline methods.
What Are The 3 Types Of Arbitrage?
- Spatial Arbitrage: Exploiting price differences of the same asset in different locations.
- Temporal Arbitrage: Capitalizing on price discrepancies of the same asset at different times.
- Statistical Arbitrage: Using complex models to identify price differences among related assets.
Why Should I Invest In Arbitrage Funds?
Invest in arbitrage funds for their low-risk profile, ability to generate steady returns in volatile markets, and more favorable tax treatment compared to traditional debt funds, making them suitable for conservative investors.
What Are The Advantages Of Arbitrage Funds?
The main advantage of arbitrage funds is their potential to offer stable returns with lower risk by exploiting market inefficiencies, along with the benefits of equity-like taxation for long-term investments.
We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, commodity and hence we bring you the important topics and areas that you should know:
