[May 2020] Arbitrage Funds – Should you invest in it ? – Details & Review

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Arbitrage Funds, as the name suggests, are the funds which make money from Arbitrage opportunities.  Many investors are not familiar with this type of Mutual Funds. They normally know Equity Funds and Debt Funds etc and think Arbitrage Funds are just other fancy schemes under Equity Funds. However this is not the case.

Arbitrage Funds Definition / Meaning


“Arbitrage” means – The simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset.

Actually, Arbitrage Funds are niche category of mutual funds that aim to take advantage of arbitrage opportunities between spot (cash) and future markets. The arbitrage is sought by taking advantage of the mis-pricing between the cash and the derivatives market. So they trade in Equity & Equity derivatives but generate income similar to Fixed Income.

Let’s understand through an example

This return is risk free as both contract (buy & sell) are taken at the same time. Irrespective of market price on 30/06/2020, the profit will be Rs 20 per share.

  • If the share goes above 1920, the trader will loose on Futures but gain on spot shares.
  • If the shares goes below 1920, the trader will gain on Futures but loose on spot shares.

How do they generate returns?


The ability of these funds to generate higher returns depends on the volatility in equity markets – the higher the better. Fund Managers use sophisticated software’s that flag any mispricing the moment it occurs.

 Arbitrage funds taxation aspects


Taxation is one of the USP for Arbitrage funds. While it is a substitute for debt products on a risk-return basis, arbitrage funds are taxed as equity.

    • So, the long-term returns (after 1 year) will be taxed at just 10%. Note that the returns upto Rs 1 lakh is tax free.
    • The short-term capital gains are taxed at a special rate of 15%, plus surcharge.

Arbitrage funds can act as an alternative to short-term debt funds as they have generated higher returns in the short-term.

Returns of Arbitrage Funds (Best performing Arbitrage Funds)


Mostly for other type of funds, I show the CAGR return over 1 year, 3 year and 5 years, but for Arbitrage funds, it is better to see their returns over a short term. Therefore, the

Point to Note


    • Arbitrage & Arbitrage Plus –   Investors need to differentiate between pure arbitrage and arbitrage plus funds. In the former, the equity component is completely hedged while the latter can take unhedged positions and carry a higher risk.
    • These funds should have an equity holding of over 65% to be classified as equity funds.
    • Returns are similar to Interest rates prevailing in the market but are more tax efficient. 
    • The main difference between Arbitrage funds & debt funds are Taxation aspects as discussed above.
    • Debts funds invest in Fixed Income Securities and have interest rate risk while Arbitrage funds are almost risk free.

Summary


Arbitrage funds are good option for Investors in higher tax bracket as they generate risk free income and are tax efficient.

 Feedback


Have you heard about these funds before reading this article? Have you invested in Arbitrage funds before? What are your views on such funds? Do you have any query related to such Arbitrage funds?

18 COMMENTS

  1. Can you suggest a PURE arbitrage fund with low expense ratio and regular dividends? I am interested in the tax free dividends.

    • Hi Fahd, Some of the arbitrage funds having lowest expense ratio are as below:

      Axis Enhanced Arbitrage Fund – Direct Plan (0.25%)
      Birla Sun Life Enhanced Arbitrage Fund – Direct ( 0.33%)
      ICICI Prudential Equity Arbitrage Fund – Direct Plan – (0.34%)
      L&T Arbitrage Opportunities Fund – Direct Plan – 0.36%
      Reliance Arbitrage Advantage Fund – Direct Plan – 0.39%

  2. This is the first time im hearing about this fund type and its second alternative to ELSS to me as im in the beginning stage of investing …..

    thank you for this nice post

    I didnt understand the point that to be considered as equity ,, it should hold 65%?

    What is the minimun and maximum amount to invest in Abitrage funds..

    Thank you Sir…..

    How to invest arbitrage fund through online….

    • Arbitrage funds are funds which take benefit of opportunities between Cash & Derivatives segment of Equities.
      To get benefit of Equity fund taxation, it should invest 65% in Equities. most Arbitrage fund fall under this category only. So no worries.

      You can invest in Arbitrage funds like any other funds. Go to the fund house’s website & invest.

      The amount depends on how much to invest. it is more of an alternative for FD returns and short term investment like 1-2 years.

  3. Hi Vivek,
    Very nice and informative article. Can you please suggest is it safe to invest lump sum amount in arbitrage funds, say 3- 4 lakhs at a time or SIP is better. Please give your expert opinion. I am in 30% tax bracket.
    Thanks. Regards.
    Suresh

      • Hi Vivek,

        I am an NRI returning to india.

        Was looking for an instrument to save tax on my FD corpus in NRE Account.

        Seems arbitrage funds are good option…Please answer

        1) Should one invest lump sum about 20-25 lacs in these funds.
        2) If answer to Q-1 is yes, Suggest some funds to invest with split in each.
        3) What is your overall estimate of returns over 2 yr period on this corpus in arbitrage funds.

        Regards
        Pankaj

        • Hi Pankaj,

          1) Yes you can invest in Arbitrage funds as they are tax friendly if held for 1 year
          2) Most of Arbitrage funds give similar returns. You can consider investing in 3-4 funds (HDFC arbitrage, Reliance Arbitrage, ICICI arbitrage & Kotak Arbitrage)
          3) The returns are typically in line with FD interest rates. ( i.e. you can expect 7-8% returns)

  4. Hi Vivek,

    This post is very good.

    Can you please tell me or suggest any Online agency, which can provide courses on Arbitrage for stocks/equities as well?

    Are you aware of any such agency or university which does provide a detailed and practical course in Arbitrage?

    Any help is greatly appreciated!

    thanks and regards,
    Jovy

  5. Hi,
    i have read most articles of yours and are all good & informative.

    I need your help to do tax calculation.
    I m a design engg. and working in a company as contract empolyee past 4 months. My salary is 75000 it may vary month-to-month based on my working hours.
    in the salary they deduct only 1% and giving remaing as my salary. while tax declaration, they informing that i have to do by own.
    Previously i had worked in another co. as contract basis and they deducted 10% as TDS in my salary.
    Kindly give advise what i have to do. Either to show all my tax exemption or just to leave it.

    • Hi Mahi,

      It seems that your current company is deducting TDS @ 1% u/s 194C treating you as a contractor. Normally 194C is applied on following kind of work
      1.Catering
      2.Advertisement work
      3.Carriage of goods and passengers by mode other than railways
      4.Manufacturing of any product according to requirement of customer and using material provided by him.
      5.Broadcasting and telecasting

      For professional services, TDS is deducted @ 10% U/s 194J (TDS on professional services)

      Whether TDS is deducted at 10% or 1% , you should not face major issues. As you need to show the total income earned while filing Income tax returns & claim the TDS deducted. Any balance needs to be paid / refunded.

      For e.g. suppose you got 75000 pm in old company & they deduct 10% TDS ( for 8 months)
      & your new company – you got 75000 pm in & they deduct 1% TDS ( for 4 months)+
      So your total eearning will be Rs 9 lakhs & TDS deducted will be Rs 63000. You need to calculate the tax on Rs 9 lakh & then claim the TDS. Any shortfall, you need to pay self assessment tax.

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