When should we invest in Arbitrage Mutual funds?
This post is based on request from Shiv Anand on “Suggest-a-topic” to write on arbitrage mutual funds. Generally mutual funds invest in a variety of stocks across sectors or in debt markets. Arbitrage mutual funds on the other hand en-cashes opportunities that arise when there is a difference between prices of an asset between two or more markets. In this article I would detail about when to invest in such Arbitrage Mutual funds and when not to invest in such funds.
How exactly Arbitrage mutual funds work?
Arbitrage mutual funds work on any opportunity that comes up when there is variation between the prices of an asset under different market conditions. Below are the 3 scenarios.
- The difference in price for a stock between BSE and NSE
- Difference between spot market and future market for a particular stock
- Difference between future contract of a month Vs futures contract for 2 months or 3 months.
Let me explain this with an example. Reliance stock price is around Rs 800. Now during market trading time in NSE it might be quoting Rs 805, but in BSE it might be still available at Rs 800. One can buy in BSE and sell at NSE and make a difference of Rs 5 per share (minus transaction charges).
When should we invest in such arbitrage mutual funds?
These arbitrage mutual funds are good to invest under the following conditions:
- When volatility increases or prevails in the market
- During political changes where markets are highly volatile
When we should avoid such Arbitrage funds?
- When markets have stabilized there is no scope for volatility, hence investing in arbitrage funds would not yield much returns.
- When interest markets are likely to head down, investing in debt mutual funds would be a good option instead of Arbitrage funds.
How the returns are comparable with other category of mutual funds?
The returns are generally comparable with liquid funds and would be around 7% to 8% per annum. Hence don’t expect high returns from such funds.
Does anyone is investing in such Arbitrage funds?
No doubt this is one of the good category of mutual funds, howeever they perform better during volatile markets. Below are the top Arbitrage mutual funds and their performance in last 5 years.
What is the tax treatment for returns from Arbitrage funds?
One good part is that the returns from Arbitrage funds are taxed like equity funds. The reason is such funds invest in direct stock markets either in the spot market or futures market. Hence any returns for more than 1 year are treated as capital gain and the tax on that would be zero.
Conclusion: Arbitrage funds are meant to provide good returns when markets are volatile. Hence if there is such a market condition, invest in arbitrage funds to reduce risk and get good returns, else invest in long term debt mutual funds to gain more.
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