Earning income with minimum risk is what every investor yearns for. However, volatile markets expose investors to more risk and they panic about losing money. This is where an arbitrage mutual fund can come handy, as it uses market volatility to its advantage.
An arbitrage fund invests in opportunities arising out of the price arbitrage between cash and futures markets. It involves buying a stock in the cash market and simultaneously selling the same in the same quantity in the futures market at a premium.
This arbitrage between spot market and futures market tends to narrow as the expiry date of the futures contract comes closer and converges on the expiry date. Arbitrage funds opt for a strategy in which all positions are hedged completely.
This mitigates the risk associated with market volatility. At the end of expiry, the fund generates risk free profit, which is equal to the premium.
Utility
Arbitrage funds are safe avenues to park money for the short term. Their risk level is comparable with pure liquid funds, ultra-short term funds and short-term funds. These funds are apt for risk-averse individuals looking to park their surplus money safely, especially when there is persistent volatility in the market.
If your clients have to park excess funds to create an emergency fund, you can look at arbitrage funds to earn higher returns. Moreover, if your clients have already invested in riskier options such as equity funds and are approaching to achieve their financial goals, begin a STP from the equity funds to a less risky fund like arbitrage funds.
Taxation
For taxation, these funds are treated as equity funds. That means, investors have to pay short-term capital gains (STCG) of 15% + applicable surcharge if they redeem their units within one year. For holding period of more than a year, long-term capital gains (LTCG) is applicable. Currently, LTCG in excess of Rs.1 lakh a year is taxed at the rate of 10%. Simply put, your clients can use arbitrage funds to earn tax-efficient returns.
Among arbitrage funds, Aditya Birla Sun Life Arbitrage Fund is a good choice. The investment strategy of this fund establishes a non-directional trade. As a result, it has generated predictable and risk free returns since inception.
The fund takes into account multiple factors like FX hedging costs, sentiment of equity market participants, interest rates in the economy and open interest in the equity derivative markets and so on to deploy funds.
Further, the scheme has exposure to high quality debt instruments of very short maturities to provide liquidity and additional yield.
In addition, the fund is ideal for Systematic Withdrawal Plans (SWP) as it has no exit loads after a month.
