Arbitrage funds are indeed a part of mutual funds. They fall under the category of hybrid mutual funds as they typically invest in a mix of equity and debt instruments.
What are Arbitrage Funds?
Arbitrage funds are a specific type of mutual fund that aims to generate returns by exploiting price discrepancies (differences) of the same asset across different markets or segments. The core strategy is based on the concept of arbitrage, which is the simultaneous buying and selling of an asset to profit from these temporary price differences.
The most common arbitrage strategy employed by these funds is cash-and-carry arbitrage, which involves:
- Buying a stock in the cash (spot) market (where transactions are settled immediately) at its current price.
- Simultaneously Selling an equivalent quantity of that same stock in the futures (derivatives) market at a higher price.
The difference between the higher futures price and the lower cash price (minus transaction costs) is the profit that the fund aims to lock in, irrespective of future market movements. This is because, by the time the futures contract expires, the cash and futures prices of the underlying asset are expected to converge.
If no such arbitrage opportunities are available, arbitrage funds typically park a portion of their assets in debt and money market instruments to ensure liquidity and generate some return.
Key Characteristics and Uses:
- Low Risk: Arbitrage funds are generally considered low-risk compared to pure equity funds. This is because their positions are largely “hedged” – the simultaneous buy and sell transactions neutralize the impact of market price fluctuations. The risk primarily comes from the fund manager’s ability to execute these trades effectively and the availability of arbitrage opportunities.
- Market-Neutral Strategy: They aim to generate returns regardless of whether the stock market is going up, down, or sideways. They thrive on market inefficiencies and volatility, as these conditions tend to create more price discrepancies.
- Tax Efficiency: In India, arbitrage funds are treated as equity-oriented funds for taxation purposes because they typically invest at least 65% of their assets in equity and equity-related instruments (even if hedged). This often makes them more tax-efficient than debt funds for short to medium-term investments, especially when considering long-term capital gains tax benefits (10% on gains over ₹1 lakh if held for more than 1 year).
- Suitable For:
- Investors seeking relatively stable, low-risk returns in the short to medium term (e.g., 6 months to 2 years).
- Those looking to park emergency funds or surplus cash for a period longer than a liquid fund, benefiting from better tax treatment than traditional debt funds or savings accounts.
- Individuals who want a low-volatility investment option during volatile market periods.
In summary, arbitrage funds are a unique type of mutual fund that leverages market inefficiencies to generate returns with a relatively low-risk profile, making them a suitable option for specific investor needs.
You’re right to ask for specific examples! The Indian mutual fund market has several prominent Arbitrage Funds. Here are a few examples from different Asset Management Companies (AMCs):
Popular Arbitrage Funds in the Indian Market:
- Kotak Equity Arbitrage Fund
- ICICI Prudential Equity Arbitrage Fund
- Nippon India Arbitrage Fund
- HDFC Arbitrage Fund
- SBI Arbitrage Opportunities Fund
- Aditya Birla Sun Life Arbitrage Fund
- Tata Arbitrage Fund
- Edelweiss Arbitrage Fund
- Axis Arbitrage Fund
