What Are Arbitrage Funds? Are They The Best Short-Term Investment Options?

Last updated:
Arbitrage Funds as a Stable Investment Option

Unlock the mysteries of arbitrage funds.

The best part?

We delve deep into the mechanics of arbitrage funds and how they can potentially offer a stable investment opportunity, even in volatile markets. Wondering how these funds might consistently deliver returns while many investments waver?

We've got answers!

If you're aiming for a short-term investment that balances risk and returns, or you're curious about diversifying your portfolio beyond the usual stocks and bonds, then understanding arbitrage funds is crucial for you.

Ready to unravel this financial tool? Let's break it down.

What Are Arbitrage Funds?

Arbitrage funds are a type of mutual fund or investment strategy that aims to take advantage of price differences (arbitrage opportunities) between related financial instruments in different markets or segments.

These funds typically exploit price differentials between securities traded on different stock exchanges, between cash and derivative markets, or between various segments of the same market.

The primary goal of an arbitrage fund is to generate returns with relatively lower risk compared to other investment strategies. This is achieved by simultaneously buying and selling the same or similar assets to profit from price discrepancies.

For example, if a stock is trading at a higher price in one market than in another, an arbitrageur could buy the stock in the lower-priced market and sell it in the higher-priced market, thereby making a profit from the price difference.

Types of Arbitrage Funds

There are a few common types of arbitrage strategies that these funds may employ:

1. Cash-Futures Arbitrage

This strategy involves buying securities in the cash market and selling corresponding futures contracts in the derivative market. The fund aims to profit from the price difference between the cash and futures markets.

2. Equity Arbitrage

In this approach, the fund manager identifies price differences between related stocks, such as those involved in a corporate event like mergers, acquisitions, or stock splits, and aims to capitalize on these price gaps.

3. Index Arbitrage

Here, the fund takes advantage of price differences between the components of an index and the price of the index itself. By buying and selling the underlying stocks and index futures, the fund aims to benefit from discrepancies.

4. Cross-Market Arbitrage

This involves exploiting price differences between securities listed on different stock exchanges or markets. The fund can buy in one market and sell in another to profit from the price gap.

Features Of Arbitrage Funds

Since they are much less talked about, people don't know much about these funds. But if you invest your money in arbitrage funds smartly, the gains are foreseeable. The major features of arbitrage funds are as below:

1. Balance Of Risk And Return

The basic objective of investing in these funds is to create that balance of risk and return. The higher the risk, the higher the return as well. As a new investor, you should take low risk and get rewarded for it at a low rate too. Once you understand the market better, you may up the level of risk with time.

2. Not Affected Negatively By Fluctuations

A good aspect of arbitrage funds is that they are not affected negatively by the fluctuations taking place in the market prices. This is an important aspect to keep in mind as you can invest in these funds even if the market prices of stocks are generally low. As long as you keep your eye on the expense ratio, we are sure that these funds won't bring you major losses.

3. Actively Managed Funds

Another good part about arbitrage funds is that they are actively managed. It means that these funds are managed by a portfolio manager who makes solid investment decisions.

These are the experts who know most of the stock exchanges. Therefore, they keep trading their funds on all these exchanges to bring the best possible returns.

4. Avoiding A Majority Of Risk

We have told you how price fluctuations don't have a huge impact on arbitrage funds. It takes place when the fund is invested in equity funds, which are considered to be the most risky option of them all. These funds help investors avoid a majority of the risks associated with equity market volatility.

5. Investment In Debt Instruments

There are times when arbitrage opportunities are low. In such a case, the pool manager draws some of the invested capital out and puts it into the debt instruments. Since the returns on debt instruments are fixed, it would divert major losses from your portfolio. The money is put into debt instruments that have a high credit quality, like debentures, government bonds and term deposits.

Here Are The 10 Best Arbitrage Funds In India

If you need to invest your money in Arbitrage funds, you should look into the following 10 options. These are the funds providing the best returns to investors consistently:

FundsAssets Under Management (AUM) Expense Ratio Absolute Returns - 1Y (%) 
Edelweiss Arbitrage Fund5,393.170.37%5.96%
Invesco India Arbitrage Fund3,184.740.38%6.58%
Nippon India Arbitrage Fund8,086.040.21%5.82%
Kotak Equity Arbitrage Fund19,522.210.43%6.02%
Baroda BNP Paribas Arbitrage Fund331.790.49%5.30%
Axis Arbitrage Fund3,085.180.31%5.69%
Aditya Birla SL Arbitrage Fund3,551.600.36%5.73%
HSBC Arbitrage Fund2,344.770.29%5.54%
Bandhan Arbitrage Fund3,630.170.37%5.80%
ICICI Pru Equity-Arbitrage Fund11,272.760.39% 5.76% 

Disclaimer: The list is for informational purposes only. Investors are advised to conduct thorough research and consult with financial professionals before making any investment decisions. Past performance is not indicative of future results.

Advantage Of Investing In Arbitrage Funds

There are several good aspects of investing in arbitrage funds as well. We shall take a look at some of the highlighted benefits regarding them:

1. Less Risk

Just like any mutual fund, the amount of risk involved with arbitrage funds is low. The fund manager already knows the buying and selling rates of the stocks. He would manage the risk efficiently based on these rates.

2. Taxed As Equity Funds

Generally, debt funds are taxed high. So if you invest in those funds, you will have to pay a major portion of your income as tax too. Since arbitrage funds are taxed as equity funds, the tax rate is going to be much lower.

3. Balanced Funds

Equity and debt funds come with limitations of their own. In a certain market condition, it might be more suitable to invest in equity and the scenario might be opposite in a different market condition. Arbitrage funds create a hybrid of both debt and equity, with a focus on equity, thus capturing the benefits of both asset classes.

4. Best Suited For A Volatile Market

In case the market situation is not good, you might avoid investing in debt as well as equity funds. This is where you can trust arbitrage funds as they are best suited for a volatile market.

Difference Between Arbitrage Funds And Fixed Deposits

While they might have some common characteristics, there's a huge difference between Arbitrage funds and FDs. We shall look at some points of differences here below:

Features Arbitrage Funds Fixed Deposits
Returns The returns are dependent on the market conditions. Therefore, they cannot be guaranteed.The returns are guaranteed as you get assured based on the bank rate.
Taxation Short-term capital gains are taxed at 15% here. Meanwhile, Long-term capital gains are taxed at a lower rate of 10%. The interest earned is added to the income of the investor. This income is taxed as per the income tax slab.
Risk While arbitrage funds are generally considered less risky, there's a higher risk involved when compared with FDs.Negligible risk is involved with FDs.
Premature Withdrawal If you draw these funds before their maturity, an exit load will be levied. A premature withdrawal fee is levied as per the bank/financial institution’s norms. 

Are Arbitrage Funds The Best Short-Term Investment Options?

So, when it comes to short-term investments, you might have heard about arbitrage funds as a solid option. These funds work by taking advantage of price differences between different markets, which can lead to more stable returns that aren't entirely hitched to market ups and downs.

While they do offer a nice bit of stability compared to riskier ventures, it's worth keeping in mind that how well they perform can change based on how the markets are behaving.

To figure out if they're the right fit for your short-term investment plans, it's a smart move to discuss with financial experts and think about your own comfort with risk and what you're aiming for with your investments.

Final Analysis

In the complex world of finance, arbitrage funds have emerged as a compelling investment option. These funds aim to exploit price discrepancies across markets or instruments, often resulting in minimal risk for the investors.

While they may seem lucrative, especially for short-term goals, it's essential to understand that returns are often on par with liquid funds and can be influenced by various market factors.

To begin your journey with arbitrage funds:

  • Visit a reputable platform like INDmoney.com.
  • Ensure your KYC details are up-to-date and complete the registration process.
  • Upload necessary documents like PAN, Aadhar, etc.

We've delved deep into a variety of funds and investment opportunities previously. For more insights, check out the INDmoney app.

If this article provided value to you, please consider sharing it with your network. Thank you!