Arbitrage Mutual Funds

We are aware that the equity market is highly volatile. However, masters of the trade capitalize on this volatility to leverage and use them to spin investment opportunities for them. Arbitrage funds focus on leveraging this market volatility. They function on buying and selling securities, commodities, or currencies simultaneously from different diverse markets to derive benefits from the difference in their price points at various vends.

In simpler words, an arbitrage fund is an equity fund that invests in equity derivative instruments, like stocks, and plays on the price advantage between two market segments.

Who Should Invest in Arbitrage Mutual Funds?

Arbitrage funds are balanced or hybrid funds as they invest in both debt and equity, but their primary investments are in equities. Even though Arbitrage funds are relatively low-risk funds, their payoffs, or arbitrage fund returns, are unpredictable. They are another variant of mutual funds. They function on the principle of purchasing stock in the cash market and simultaneously selling off that interest in the futures market.

Hence, people who should ideally invest in these funds are:

  • Those with cash surplus want to make extra earnings instead of keeping them idle in their savings account and earning a very small interest rate.
  • Anyone looking for a short to medium-term investment strategy should go in for investing in Arbitrage funds.
  • The term period of 3 to 5 years is ideal for investing in such funds. Hence, those with extra funds and who do not have immediate cash requirements can hold on to them for some time.
  • Those who desire to profit from volatile markets yet do not want to get involved and invest in high-risk sectors.
  • These funds charge exit loads. Hence, keeping this in mind, arbitrage funds should be considered for investments only by those who would retain their money in them for at least 3 to 6 months.
  • These funds are good for people under the higher income bracket, as they can use their surplus funds to invest and earn profits on them.

Features of Arbitrage Mutual Funds

Arbitrage funds offer multiple benefits to investors. Hence, they appeal most to investors with low-risk tolerance. These funds are born to rule only when the markets are volatile. However, if there is a shortage of profitable arbitrage trades, the funds are invested more heavily on debts. This retains them at low-risk levels, unlike longer-term investment funds.

The features of arbitrage mutual funds are:

  • Positive Returns
    With Arbitrage funds, you can generate positive returns when the market is volatile.
  • Equity Oriented
    Arbitrage funds work on similar lines as equity funds in terms of tax treatment. Hence, they prove to be very tax-efficient.
  • Insignificant Investment Risks
    Amongst other equity investments, arbitrage funds offer relatively risk-free returns.
  • Hedged Exposures
    Arbitrage funds get fully hedged exposure to equities, and they aim to generate returns through them.
    It should be kept in mind that arbitrage funds charge an annual fee which constitutes a percentage of their overall assets. Also, there is an exit load that is levied to discourage investors from exiting early. All these should be considered carefully before stepping ahead to invest in these funds.

Factors to consider while investing in Arbitrage Funds

Here are the parameters you must evaluate before investing in arbitrage funds:

Arbitrage Funds’ Performance

Big mutual fund houses like Axis, Tata, UTI, Invesco, HDFC, DSP, L&T, and the like offer arbitrage funds. However, despite being managed by some of the best arbitrage fund managers in India, not all arbitrage funds provide similar returns. 

So, you must check the historical performance of the best arbitrage funds before picking one or more funds to invest in. Also, analyzing a minimum of three years’ data is wise to arrive at a solid conclusion. 

Generally, if a fund performs decently for three to five years, it is believed that the momentum will also continue in the coming years.    

Comparison With The Benchmark

Benchmark refers to the average returns offered by the underlying stocks or financial instruments the benchmark is composed of. The benchmark shows the status of the index or the sector it tracks. 

For instance, if the benchmark S&P BSE Information Technology TRI increases, it proves that IT sector stocks are attracting investors’ interest. Funds are compared vis-a-vis the benchmark it follows. Generally, arbitrage funds’ performances are measured against the performance of the NIFTY 50 Arbitrage TRI. 

Remember, the best arbitrage funds are the ones that consistently outperform the benchmark. Also, you may invest in funds that outperform the benchmark and the category.

The Expense Ratio

The expense ratio refers to the fee mutual fund houses charge to manage investors’ capital assets. They use the amount to cover their establishment costs. However, since the expense ratio reduces the investor’s profit margin, it is imperative to evaluate the ratio to maximise profits. 

The Securities and Exchange Board of India (SEBI) has laid detailed guidelines on the expense fees mutual fund houses can charge customers. It specifies the maximum expense ratio fund houses may levy on specific fund types. However, fund houses or AMCs (Asset Management Companies) often charge lower expense rates than the SEBI-set limit to attract customers.   

Before investing in the best arbitrage funds, it is wise to evaluate the expense ratio. Generally, the arbitrage fund expense ratio hovers between 0.30% and 0.45%. Remember, the lower the expense ratio, the more capital invested in the market. Hence, a lower expense ratio might increase your profits as well. 

Taxation

Arbitrage funds are considered equity funds for taxation. So, if you hold your investment for more than a year, you must pay an LTCG (Long Term Capital Gains) tax of 10% + surcharge + cess on the profit. However, if you sell your investment before one year from the investment date, the STCG (Short Term Capital Gains) tax rate will be 15% + surcharge + cess. It is wise to note that you have to pay INR 0 if your LTCG is less than INR 1 lakh in any financial year. 

So, before investing or withdrawing money from an arbitrage fund, calculate your taxes to maximise your income.

Financial Goals 

Despite being classified as equity funds and taxed accordingly, arbitrage funds are not always as remunerative as pure equity funds. But, arbitrage funds are typically more stable and less volatile than pure equity funds. So, arbitrage funds are best-suited for investors with a long-term investment horizon. Tracking the past performance of the funds can give you an idea about the returns you may expect. Hence, tie your arbitrage fund investments with a financial goal and invest accordingly. 

Exit Load

Exit load refers to the amount mutual fund houses charge for allowing withdrawals before a specific date from the investment date. Arbitrage funds’ exit load generally ranges between 0.25% and 1%. Check the exit load to make sensible investment decisions.   

Fund Manager’s Expertise

Arbitrage funds are usually more complicated than standard equity or debt funds. So, the fund manager’s expertise plays a massive role in determining the returns. Generally, Indian mutual fund houses assign arbitrage fund management to the best fund managers. However, it is still wise to check the fund manager’s track record before investing in the best arbitrage funds. 

Taxability of Arbitrage Funds

Since arbitrage funds involve 65% of their holding in equities, they are categorized as equity funds and are taxed accordingly. This way, these funds earn the advantage of zero taxability on long-term capital gains (LTCG). If the funds are held on for more than a year, they fall under the category of LTCG and are completely tax-free.

The taxation policies for arbitrage funds are:

  • For an investment period of less than a year, for any amount of returns gained, the nature of tax would be considered as short-term capital gains (STCG), and the tax rate applicable would be 15%.
  • When the investment period is more than a year, and the returns gained are less than a lakh, the tax would be considered long-term capital gains (LTCG), and it would be fully exempt from tax. And if the returns gained are more than a lakh, the tax would be considered long-term capital gains (LTCG), and the applicable tax rate would be 10% without indexation benefits.

However, the tax rates applicable on arbitrage funds, as of date, are lower in comparison to any other debt funds.

Risks Involved With Arbitrage Funds

Arbitrage funds are hybrid funds, primarily investing in debt funds that yield low returns, differentiating them from managed equity mutual funds. You need to keep the following points in mind before going ahead and investing in them.

  • Ensure your financial goals align with the fund’s future objectives. Such funds are best suited for short to medium-term goals. Hence, instead of keeping their excess funds idle in a savings account, they can invest them in arbitrage funds to earn extra returns.
  • Various costs like entry load, exit load, expense ratio, etc., come attached when investing in arbitrage funds which should be calculated beforehand as frequent trading may lead to high transaction costs and a substantial turnover ratio.
  • Whichever fund you choose to invest in, keep an eye on its performance in both bearish and bullish market conditions. This way, you would select one of the best arbitrage funds and the most reliable one in a volatile market scenario.
  • Tax on arbitrage mutual funds is the same as equity funds, considering this factor as arbitrage funds are mediocre reliability funds.

Advantage of Arbitrage Mutual Funds

Arbitrage funds are good when you expect to get moderate returns from your investments. The advantages of investing in these funds are:

Low on Risk

Arbitrage funds are low-risk securities. Since these funds buy and sell securities frequently, there are no long-term risks involved.

Suitable for the Volatile Market

Even in a highly volatile market, arbitrage funds flourish well. Through fast buying and selling of stocks in different markets, these funds use the volatility feature to their advantage to generate returns for their investors.

Taxed Similar to Equity Funds

Equities constitute around 65% of the arbitrage funds and hence are taxed similarly to them. Therefore, they yield a higher tax advantage rate on returns over other funds.

Best Arbitrage Mutual Funds

The availability of high-quality arbitrage funds may spoil you for choices. The following sections make your task of fund selection easy. Here is the list of top-performing arbitrage funds in India in 2022:

Tata Arbitrage Fund

  • Tata Arbitrage Fund Direct-Growth spots arbitrage opportunities in the spot and futures markets of exchange-traded equities and scans arbitrage opportunities in the derivatives segment. The fund also has exposure to debt and good-quality money market instruments. The asset size of this fund is INR 7,985 Crore as of 31st July 2022. The top debt holdings of this fund are 6.84% GOI 19/12/2022, HDFC Bank 17/08/2022, and 5.35% LIC Housing Fin. 20/03/2023, etc. The top equity holdings of this fund are HDFC Bank, TCS, HCL Tech, Adani Enterprise, Maruti Suzuki, Tech Mahindra, etc., as of 31st July 2022. The fund’s expense ratio is 0.29% as of 30th June 2022, and the exit load is 0.25% for withdrawals made before 30 days from the investment date. The benchmark of this fund is NIFTY 50 Arbitrage TRI.
  • Fund Manager – Mr. Sailesh Jain
  • Minimum Investment – INR 5,000
  • Minimum SIP Investment – INR 150
  • Minimum Withdrawal – INR 500
  • Fund’s Performance – Tata Arbitrage Fund Direct-Growth was launched on 18th December 2018 and has delivered returns of 3.87% in 1-year, 5.02% in 3-year, and 5.49% since inception. 

Edelweiss Arbitrage Fund

  • Edelweiss Arbitrage Fund Direct-Growth spots arbitrage opportunities in the spot and futures markets of exchange-traded equities and scans arbitrage opportunities in the derivatives segment. The fund also has exposure to debt and good-quality money market instruments. The asset size of this fund is INR 6,648 Crore as of 31st July 2022. The top debt holdings of this fund are 7.21% HDFC 30/12/2022, 7.16% GOI 20/05/2023, 6.84% GOI 19/12/2022, etc. The top equity holdings of this fund are HDFC Bank, Reliance Industries, HDFC, HCL Tech, Sun Pharma, Wipro, Piramal Enterprise, etc., as of 31st July 2022. The fund’s expense ratio is 0.35% as of 30th June 2022, and the exit load is 0.1% for withdrawals made before 30 days from the investment date. The benchmark of this fund is NIFTY 50 Arbitrage TRI.
  • Fund Manager – Mr. Bhavesh Jain
  • Minimum Investment – INR 5,000
  • Minimum SIP Investment – INR 500
  • Minimum Withdrawal – INR 500
  • Fund’s Performance – Edelweiss Arbitrage Fund Direct-Growth was launched on 27th June 2014 and has delivered returns of 4.20% in 1-year, 4.92% in 3-year, 5.72% in 5-year, and 6.53% since inception. 

Axis Arbitrage Fund

  • Axis Arbitrage Fund Direct-Growth spots arbitrage opportunities in the spot and futures markets of exchange-traded equities and scans arbitrage opportunities in the derivatives segment. The fund also has exposure to debt and good-quality money market instruments. The asset size of this fund is INR 4,925 Crore as of 31st July 2022. The top debt holdings of this fund are 6.84% GOI 19/12/2022, Reserve Bank of India 182-D 22/12/2022, National Bank Agr. Rur. Devp 14/02/2023, SIDBI 2023, etc. The top equity holdings of this fund are HDFC Bank, Reliance Industries, DLF, ICICI Bank, Bharti Airtel, etc., as of 31st July 2022. The fund’s expense ratio is 0.31% as of 30th June 2022, and the exit load is 0.25% for withdrawals made before 7 days from the investment date. The benchmark of this fund is NIFTY 50 Arbitrage TRI.
  • Fund Manager – Mr. Ashish Naik
  • Minimum Investment – INR 5,000
  • Minimum SIP Investment – INR 1,000
  • Minimum Withdrawal – INR 1,000
  • Fund’s Performance – Axis Arbitrage Fund Direct-Growth was launched on 14th August 2014 and has delivered returns of 4.40% in 1-year, 4.78% in 3-year, 5.62% in 5-year, and 6.39% since inception. 

Invesco India Arbitrage Fund

  • Invesco India Arbitrage Fund Direct-Growth spots arbitrage opportunities in the spot and futures markets of exchange-traded equities and scans arbitrage opportunities in the derivatives segment. The fund also has exposure to debt and good-quality money market instruments. The asset size of this fund is INR 1,489 Crore as of 31st July 2022. The top debt holdings of this fund are Reserve Bank of India 182-D 18/08/2022, Reserve Bank of India 364-D 01/12/2022, Reserve Bank of India 182-D 24/11/2022, Reserve Bank of India 364-D 05/01/2023, etc. The top equity holdings of this fund are HDFC Bank, The Federal Bank, Granules India, TCS, Axis Bank, etc., as of 31st July 2022. The fund’s expense ratio is 0.36% as of 30th June 2022, and the exit load is 0.50% for withdrawals made 15 days from the investment date. The benchmark of this fund is NIFTY 50 Arbitrage TRI.
  • Fund Manager – Mr. Deepak Gupta
  • Minimum Investment – INR 1,000
  • Minimum SIP Investment – INR 500
  • Minimum Withdrawal – INR 1,000
  • Fund’s Performance – Invesco India Arbitrage Fund Direct-Growth was launched on 1st January 2013 and has delivered returns of 4.42% in 1-year, 4.82% in 3-year, 5.55% in 5-year, and 6.67% since inception. 

Kotak Equity Arbitrage Fund

  • Kotak Equity Arbitrage Fund Direct-Growth spots arbitrage opportunities in the spot and futures markets of exchange-traded equities and scans arbitrage opportunities in the derivatives segment. The fund also has exposure to debt and good-quality money market instruments. The asset size of this fund is INR 24,543 Crore as of 31st July 2022. The top debt holdings of this fund are Reserve Bank of India 182-D 08/12/2022, Reserve Bank of India 182-D 15/12/2022, Reserve Bank of India 182-D 22/12/2022, etc. The top equity holdings of this fund are HDFC Bank, Reliance Industries, Tech Mahindra, JSW Steel, HDFC, etc., as of 31st July 2022. The fund’s expense ratio is 0.44% as of 30th June 2022, and the exit load is 0.25% for withdrawals made before 30 days from the investment date. The benchmark of this fund is NIFTY 50 Arbitrage TRI.
  • Fund Manager – Mr. Hiten Shah
  • Minimum Investment – INR 5,000
  • Minimum SIP Investment – INR 500
  • Minimum Withdrawal – INR 1,000
  • Fund’s Performance – Kotak Equity Arbitrage Fund Direct-Growth was launched on 1st January 2013 and has delivered returns of 4.14% in 1-year, 4.74% in 3-year, 5.57% in 5-year, and 6.88% since inception. 

L&T Arbitrage Opportunities Fund

  • L&T Arbitrage Opportunities Fund Direct-Growth spots arbitrage opportunities in the spot and futures markets of exchange-traded equities and scans arbitrage opportunities in the derivatives segment. The fund also has exposure to debt and good-quality money market instruments. The asset size of this fund is INR 2,724 Crore as of 31st July 2022. The top debt holdings of this fund are 6.84% GOI 19/12/2022, Reserve Bank of India 364-D 12/01/2023, 7.16% GOI 20/05/2023, HDFC Bank 17/08/2022, etc. The top equity holdings of this fund are HDFC Bank, HDFC, Bajaj Finance, United Spirits, Trent, Bajaj Finserv, etc., as of 31st July 2022. The fund’s expense ratio is 0.35% as of 30th June 2022, and the exit load is 0.50% for withdrawals made before 30 days from the investment date. The benchmark of this fund is NIFTY 50 Arbitrage TRI.
  • Fund Manager – Mr. Praveen Ayathan
  • Minimum Investment – INR 5,000
  • Minimum SIP Investment – INR 500
  • Minimum Withdrawal – INR 500
  • Fund’s Performance – L&T Arbitrage Opportunities Fund Direct-Growth was launched on 30th June 2014 and has delivered returns of 3.63% in 1-year, 4.71% in 3-year, 5.53% in 5-year, and 6.32% since inception. 

ABSL Arbitrage Fund

  • ABSL Arbitrage Fund Direct-Growth spots arbitrage opportunities in the spot and futures markets of exchange-traded equities and scans arbitrage opportunities in the derivatives segment. The fund also has exposure to debt and good-quality money market instruments. The asset size of this fund is INR 6,796 Crore as of 31st July 2022. The top debt holdings of this fund are Aditya Birla SL Floating Rate Direct-G, Aditya Birla SL Money Manager Direct-G, and 8.37% LIC Housing Fin. 21/05/2023, etc. The top equity holdings of this fund are HDFC Bank, Reliance Industries, Axis Bank, DLF, HCL Tech, etc., as of 31st July 2022. The fund’s expense ratio is 0.32% as of 30th June 2022, and the exit load is 0.25% for withdrawals made before 30 days from the investment date. The benchmark of this fund is NIFTY 50 Arbitrage TRI.
  • Fund Manager – Mr. Lovelish Solanki
  • Minimum Investment – INR 1,000
  • Minimum SIP Investment – INR 1,000
  • Minimum Withdrawal – INR 1
  • Fund’s Performance – ABSL Arbitrage Fund Direct-Growth was launched on 1st January 2013 and has delivered returns of 3.86% in 1-year, 4.64% in 3-year, 5.50% in 5-year, and 6.78% since inception. 

Union Arbitrage Fund

  • Union Arbitrage Fund Direct-Growth spots arbitrage opportunities in the spot and futures markets of exchange-traded equities and scans arbitrage opportunities in the derivatives segment. The fund also has exposure to debt and good-quality money market instruments. The asset size of this fund is INR 94 Crore as of 31st July 2022. The top debt holdings of this fund are Reserve Bank of India 182-D 25/08/2022, Reserve Bank of India 182-D 04/08/2022, Reserve Bank of India 182-D 15/09/2022, Reserve Bank of India 91-D 15/09/2022, etc. The top equity holdings of this fund are HDFC Bank, HDFC, Reliance Industries, ICICI Bank, Infosys, UPL, JSW Steel, TCS, etc., as of 31st July 2022. The fund’s expense ratio is 0.37% as of 30th June 2022, and the exit load is 0.25% for withdrawals made before 30 days from the investment date. The benchmark of this fund is NIFTY 50 Arbitrage TRI.
  • Fund Manager – Mr Vishal Thakker
  • Minimum Investment – INR 1,000
  • Minimum SIP Investment – INR 1,000
  • Minimum Withdrawal – INR 1,000
  • Fund’s Performance – Union Arbitrage Fund Direct-Growth was launched on 27th February 2019 and has delivered returns of 3.53% in 1-year, 4.39% in 3-year, and 4.85% since inception. 

Frequently Asked Questions

Arbitrage funds offer an optimal mix of equity and debt. It invests 65% of its Asset Under Management (AUM) in equity and the remaining in high-quality debt instruments. So, any semi-aggressive or conservative investor can invest in these funds.

The expense ratio eats into the profit from a mutual fund. Fortunately, arbitrage funds’ expense ratios are some of the lowest among equity mutual funds. Generally, direct growth arbitrage funds’ expense ratio hovers between 0.30% and 0.45%.

Arbitrage funds are taxed like any equity fund. For instance, you must pay an LTCG (Long Term Capital Gains) tax of 10%, along with Surcharge and Cess, if you sell your units one year from the investment date.

However, selling your units before one year will be treated as STCG (Short Term Capital Gains), and you have to pay a tax of 15% plus surcharge and cess. However, if your income from equity funds is less than INR 1 lakh a financial year, you don’t have to pay any taxes.   

A quick look at the best arbitrage mutual funds reveals that these funds generally deliver annualized returns in the range of 4.85% and 6.88%. However, checking an arbitrage mutual fund’s historical returns is good before investing.

Exit load refers to an investor’s fee for withdrawing money before a specific period. Arbitrage mutual funds generally levy exit loads between 0.25% and 1%.

Tata Arbitrage Fund, Edelweiss Arbitrage Fund, Axis Arbitrage Fund, Invesco India Arbitrage Fund, and Kotak Equity Arbitrage Fund are some of the top arbitrage mutual funds in India.

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