All you need to know about arbitrage funds

An arbitrage fund seeks to generate returns on the price differential in the cash and derivatives market. The fund manager simultaneously buys shares in the cash segment and sells futures in the derivatives segment of the same company as long as the futures are trading higher than the shares. These funds look to benefit from the narrowing of the spread between the two securities. These schemes do not buy shares of individual companies with an intention to sell them when there is price appreciation.

Why do investors like arbitrage funds?
Arbitrage funds are considered even safer than many debt products. Debt funds carry credit risk, which is eliminated in arbitrage funds. Arbitrage funds are treated as equity funds for taxation. Investors holding these schemes for less than a year pay 15% capital gains tax, while if they sell after a year, they pay only 10% long-term capital gains tax. In a debt fund, if an Investor sells her investments before three years, the gains are added to the income and taxed as per the income tax slab.

How safe are arbitrage funds?
Wealth managers point out that arbitrage funds rank high when it comes to safety. The fund manager creates a market neutral position by buying in the cash market and simultaneously selling the same security in the futures market. Higher the volatility in the stock markets more is the opportunity. As indices trade at all-time highs, volatility is expected to increase leading to higher returns.

What returns have arbitrage funds generated in the past?
Returns from arbitrage funds are a function of opportunities available between the spot market and the futures market. Over the last one year, this category of funds has given an average return of 3.61%.