Whenever there is market volatility, you often get to hear about this category of funds –. Do you need to in it?
Let’s understand these.
They are equity-oriented funds that capitalise on price differences that exist between the cash and derivative market for a share. As the name suggests, theresorts to arbitrage strategies to make money.
Some consider it relatively safer than a regularsince simultaneous positions are taken in the cash as well as the futures market for a stock that drastically reduces risk.
Supposedly safe trading
Suppose the price of a stock ‘A’ is Rs 100 in the cash market, while the price of its one-month futures contract is quoting at Rs 102. In this case,will buy the share ‘A’ in the cash market and sell it in the futures at Rs 102. On the day of settlement (after a month that is), price in the cash and futures market will converge.
Let’s say the price on the day of settlement is Rs 103. In this case, the fund makes a profit of Rs 3 (Rs 103-100) from its ‘buy’ position in the cash market. However, it also makes a loss of Re.1 (Rs 102-103) since the future contract was sold at a lower price of Rs 102. In all, the fund pockets Rs 2 (3-1) from the entire arbitrage process.
Over the years, arbitrage funds have not been able to offer a significant advantage over returns of liquid funds. In the last three years, arbitrage funds, gave annualised return of 5.8 percent, which was lesser than that of a liquid and ultra-short- duration fund. Its higher annual expense ratio (1.02%) as against that of liquid funds (0.30%) is a dampener to overall returns.
No returns kicker
Returns of an arbitrage fund depend a lot on equity market volatility. A flat market, for instance, will result in a gain only at the end of the month, as in the above example. However, if there is market buoyancy or volatility, the opportunity to profit might arrive in a shorter time frame. Moreover, the NAV gain.needs to trade at frequent intervals in order to make a decent
Over the years,have not been able to offer a significant advantage over returns of . In the last three years, , gave annualised return of 5.8 percent, which was lesser than that of a liquid and ultra-short- duration fund. Its higher annual (1.02%) as against that of liquid funds (0.30%) is a dampener to overall returns.
Since these fundsat least 65 percent of their portfolio into equities, it enjoys lower taxes as an equity-oriented fund.
A debt fund, if sold within three years, attracts short-termtax (rate as per the investor’s slab). In contrast, held for more than a year attracts long-term tax at 10 percent. And if sold within a year, short-term tax at 15 percent is applicable.
While post-tax returns ofmight be better than that of liquid or ultra-short duration funds, there are certain caveats.
Arbitrage fund makes money on sharp market movements. And trends in movement of India VIX – a measure of expected one-month volatility in– suggest such opportunities have been hard to come. In the last five years, value of VIX was more than 20 (a volatile market scenario) only seven percent of the times. Higher the VIX, higher is the expected volatility.
Moreover, NAV ofare marked-to-market on a daily basis and its investors might incur losses on exiting before the expiry of a futures contract. Liquid funds, in contrast, are marked-to-market only if debt papers have a maturity of more than 30 days.
Investors who temporarily park their funds need safety of capital at all times (more than returns). And that’s where liquid or ultra-short duration funds score overalong with its better risk-adjusted return profile (or superior Sharpe ratios).
have underperformed liquid and ultra-short duration funds across time horizons. While it might score on the tax aspect, conservative investors are better-off parking their money in the tried-and-tested liquid or ultra-short duration funds. By doing that they are more assured of capital protection, while earning predictable returns from their .
Read also about the Arbitrage Funds Vs Liquid Funds