Arbitrage funds take advantage of the price differential of a stock in the cash market and the futures markets.
Can you give me some clarity on arbitrage funds, so that I am assured that my investment is safe and I will get higher returns in the long run?
Arbitrage funds take advantage of the price differential of a stock in the cash market and the futures markets. Typic-ally, the price of a stock in the derivatives market quotes at a premium to its price in the cash market. This allows for an arbitrage opportunity which such funds attempt to encash on by buying a stock in the cash market and selling it in the futures market thereby earning the differential premium between the two prices. Further, so as to ensure a market neutral position the value of the stock purchased in the cash market is equiva-lent to that of the futures position sold.
For taxation, arbitrage funds are treated as equity – dividends and long term capital gains (units held for 1 year and above) are tax free whereas short term capital gains (units held for less than 1 year) are taxed at 15%. In terms of liquidity, arbitrage funds carry exit loads for exit up to 1 month or so (some funds may have loads for longer periods).
Due to their return characteristics, market neutral strategy and liquidity provisions, arbitrage funds are considered debt-like, acting as substitutes for savings accounts, ultra-short term and short term debt funds and are suited for a horizon of 6 to 12 months.
If you want to generate equity-like returns over the longer term (five years and above), arbitrage funds may not be suitable and you could consider other equity funds including large cap funds, small and mid cap funds, based on your risk appetite and investment horizon.
The writer is director, Investment Advisory, Morningstar Investment Adviser (India)
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