Arbitrage Mutual Funds

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.

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.

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.

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.

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.

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.