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Arbitrage funds are tailor-made for risk-averse investors and are a safe option to park money when there is a persistent wobble in the market.

Arbitrage funds are tailor-made for risk-averse investors and are a safe option to park money when there is a persistent wobble in the market.

Earning income with minimal risk is the holy grail of all retail investors. Various investment products are being designed to address this investor psyche.

When the times are volatile, investors are exposed to more risk, and chances of losing money are high. This is where an arbitrage mutual fund, which turns market volatility to its advantage, comes into play.

An arbitrage fund – a type of equity mutual fund – rides on the mispricing between the cash markets or spot markets on the one hand and derivatives or futures markets on the other. The arbitrage opportunities arising out of substantial volatility bring relatively risk-free returns to the investors. These funds are tailor-made for risk-averse investors and are asafe optionto park money when there is a persistent wobble in the market. These funds ride on market inefficiencies to reap benefits for the investors.

The concept underlying arbitrage funds is simple – buying something at a lower price in one market and selling it at a higher price in another market to pocket profit. Consider this scenario: A companys stock is trading at Rs 1,000 in the cash market and at Rs 1,500 in the futures market. So, Rs 500 per share is the profit an investor can make by buying stock in the cash market and simultaneously selling it in the futures market. Mismatching of prices in theequity marketand futures market is the crux of the arbitrage funds.

These funds will be more profitable when the markets witness considerable volatility. More market wobble means more mispricing between the two markets to the advantage of these funds.

Arbitrage funds are safe, and carry little risk. The fund managers here reduce the risk ofequitiesby hedging against the derivatives. Market volatility doesnt entail more risk for the investor in the case of arbitrage funds. In fact, arbitrage opportunities exist only when the markets are unstable and uncertain. When the markets are stable, the arbitrage funds may not be that attractive.

Tax advantage is a great plus for arbitrage funds. When the equity holdings in the cash market are held over and above 65%, these schemes are considered as equity funds, and thats a bonanza as far as tax efficiency is considered. The returns one earns after holding these funds for more than one year are tax-free. Income from these funds within the first 12 months could be taxed at 15% in terms of short-term capital gains tax. The dividends from arbitrage funds will not attract tax, as there is no dividend distribution tax on equity funds.

Lets see where the arbitrage funds stand as compared to bank fixed deposits and liquid funds.

When it comes to returns, arbitrage funds can fetch returns of 6-9%. Bank FDs can fetch 8-9% and liquid funds somewhere between 6% and 8%. As noted earlier, arbitrage funds come out ahead as far as tax is considered, as the returns from these funds are tax-free after one year. FD and liquid fund returns are taxed as per the applicable tax slab rate.

Exiting the funds prematurely involves a nominal penalty, usually 0.25-0.5% in the first three to six months. After that, there are no charges. Liquid funds do not have penalties, but bank FDs charge a penalty of nearly 1% in case of premature withdrawal.

Arbitrage funds can be redeemed in three to five days as compared to FDs, which could be encashed in two days, and liquid funds, which can be encashed the next working day.

The arbitrage funds are not suitable for short-term investors. Also, one should hold it for at least one year to get the tax benefits. When the stock market is volatile and unstable, an arbitrage fund is the best option to reap rich dividends. One should keep in mind that as arbitrage funds are equity-based, they involve a certain element of risk. However, it is less risky compared to pure equity or other equity-based financial instruments.

(%)Mirae Asset Tax Saver Direct-G0.89-3.64-0.290.8014.36Invest NowMirae Asset Tax Saver Reg-G0.74-4.03-1.18-0.8812.79Invest NowAxis Long Term Equity Direct-G0.20-2.472.17-1.0911.04Invest NowFeatured

– Returns less then 1 year are absolute and above 1 year are annualised.

– Returns of 1 year are absolute and above 1 year are annualised..

Wealth managers advise HNIs to go for Arbitrage funds to tide over volatility

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Wealth managers advise HNIs to go for Arbitrage funds to tide over volatility

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