Top Hybrid Funds

Best Arbitrage Mutual Funds

These funds earn returns by exploiting pricing differentials in the cash and derivatives market.
Risk Tolerance: LowModerate Returns: 4% - 5%
 

Definition of Arbitrage

Arbitrage funds are a type of mutual fund that generates returns by tapping on the volatility in markets. The price differential derives the profit in the spot and futures market. When the market is expected to rise, the fund managers purchase stocks in the cash market and sell them in the futures market. If the market outlook is bearish, the underlying asset will be sold in the cash market at a higher price and purchased at a lower price in the futures market, thereby generating profit.

Arbitrage Funds

• Arbitrage funds aim to take advantage of the mispricing in stocks and futures markets.

• They keep their equity investments fully hedged. Hence, the returns are not impacted by the day-to-day fluctuations in the stock market. We take a look at how arbitrage funds try to generate a return through an easy example.

Case 1: Cash and Futures market
Arbitrage Equities: Suppose the fund manager buys a stock at Rs 100. He simultaneously enters into a futures contract to sell the stock at Rs 101. In case the time period is 1 month apart, the amount is invested into bank FDs/ other riskless instruments to get some interest income as well. Now, there are 2 possible cases at maturity.
Stock falls to Rs 90 at maturity
You lose out Rs 10 on the stock position. However, you gain Rs 11 in the futures market, thus generating a net profit of Rs 1.
Stock jumps to Rs 110 at maturity
You gain Rs 10 on the stock position, but lose Rs 9 in the futures market. Thus, the profit remains Re 1. Irrespective of the market situation, the fund manager generates the profit. Further, the interest income for 1 month.
Case 2: Both transaction in Cash market, different exchanges
The fund manager could also buy the same stock on BSE and sell it on NSE to make a risk-less profit. Today, HDFC Bank shares closed on the BSE at ₹1,028.95 and ₹1,035 on NSE.

• To take advantage of this differential, the fund manager could buy the stock from BSE at ₹1,028 and sell the same on NSE at ₹1,035 for a risk-less profit of ₹8.

Features of Arbitrage Funds:

• Arbitrage funds typically have about 70 – 80% of their portfolio invested in equity, cash and futures and about 20 - 30% in short term debt instruments.

• As discussed above, the primary source of return for these funds is to earn income from buying a stock and simultaneously selling a futures contract of the same security. This differential is referred to as the spread.

• Since the positions are hedged at all times, Arbitrage funds are a good source to earn a fixed return from parking money.

• Moreover, they are taxed at the same rate as equity funds (STCG @ 15% and LTCG @10%).

• These funds outperform in volatile times as higher volatility translates to higher spreads and better arbitrage opportunities

Advantages of Investing in the Best Arbitrage Funds

Arbitrage funds offer investors the dual benefit of low risk and tax liability in the lower tax bracket:

Things To Consider Before Investing in the Best Arbitrage Mutual Fund

How to Start Investing Online in the Best Arbitrage Funds

STEP 1
Download the INDmoney App
STEP 2
Create your profile
STEP 3
Select any best arbitrage fund from our catalogue
STEP 4
Choose between Starting a SIP or One time lumpsum
STEP 5
Complete the payment process

Outlook

The primary source of return for these funds is to earn income from buying a stock and simultaneously selling a futures contract of the same security. Since the positions are hedged at all times, Arbitrage funds are a good source to earn a fixed return from parking money. These funds outperform in volatile times as higher volatility translates to higher spreads and better arbitrage opportunities.

Frequently Asked Questions

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