15 Mistakes to Avoid while Investing in Stock Markets

Is an Arbitrage Fund the right investment alternative solution to Short duration fund?

Is an Arbitrage Fund the right investment alternative solution to Short duration fund?

In an endeavour to achieve higher returns on their investments with less risk involved, investors are constantly in search of different investment options. Initially, investors (especially the risk-averse ones) put their money on debt instruments until the mayhem of corporations defaulting to repay fiasco happened.

Already the finance industry is experiencing a lot of volatility due to macro and microeconomic factors. Equity markets are the foremost to undergo extreme highs and lows. And investing in pure equity is not suitable for the fainthearted.

In this scenario, even aggressive investors are being extra cautious.

—Advertisement—Its About to Happen Again…

In 2009, when the market sentiment was all gloom and doom, we recommended one stock that we felt was ridiculously undervalued.

And this stock, despite all the negative forecasts about the small cap stocks at the time, went on to generate 6635% returns in around 10 years.

This time, in 2019, We have found 3 stocks with a similar potential that could surprise the investor world by becoming the next big multi-bagger legend.

We are revealing details of these 3 stocks in anexclusive MEGA EventRebound Richeshappening on Nov 8th at 5:00 PM sharp.

Make sure you dont miss out on these rare bear market opportunities, and then kick yourself later. Thats what 95% of the retail investors spend their lives doing.

Claim your seat before we close the registrations.

And the current volatile environment opens a tiny door of opportunity to exploit the price differences between two markets to generate returns.

In finance, investment opportunities created by the mispricing of an asset in two different markets are called arbitrage opportunities. When you are simultaneously buying and selling the same product in different markets and locking the price differential, it becomes your clear gain, after adjusting the costs.

The mutual fund industry has a separate product category to tap suchmispricing opportunities-arbitrage funds.

An arbitrage fund is a sub-category ofHybrid fundthat seeks opportunities from differential pricing in two different segments (spot and futures or cash and derivatives) of the equity market. Such opportunities are usually tapped in volatile market conditions.

As per recategorization norms, an arbitrage fund will follow the arbitrage strategy and invest at least 65% of its total assets in equity & equity related instruments as per the mandate under normal and defensive conditions. It will also allocate the remaining assets to debt and money market instruments.

Typically, an arbitrage fund is less risky than thepure equity fundbecause participants are not speculating on market movements. Instead, they bet on the mispricing of a share/asset that has happened between two related markets. It is seen that the mispricing of security is far more frequent in high volatility months than in low volatility months.

—Advertisement—Our No. 1 Recommendation for 2020

This tiny company is Richa AgarwalsNo. 1 Small Cap Stock for 2020

It is a little-known company which trades around Rs 300, but is the backbone behind industry giants like Asian Paints, Vadilal and Heinz

And has immense profit potential for early investors.

Currently, Arbitrage funds are gaining momentum because of the new valuation norms imposed. When the great debacle in the debt market surfaced, several fund houses that had taken the investors for a joy ride were exposed.

Due to these instances, the regulator introduced a slew ofnew regulationsthat was intended to makedebt mutual fundsa lot safer place for investors. Some of those were…

Graded exit load imposed on liquid funds along with limits set forth on the duration of the exposure of instruments held.

Capping exposure on debt instruments with credit enhancements to make the debt instruments more transparent to show the actual risk involved.

All debt and money market instruments will have to value their portfolio on a mark-to-market basis now.

After the implementation of these prime regulatory norms, the fund houses reduced the holding duration of the liquid funds, but in turn, the returns have been moderate and that impacted the performance of the funds.

Per se, considering the taxation norms, Arbitrage funds are categorised as equity-oriented schemes. So, any arbitrage fund held for up to 1 year is liable for a Short-term capital gain (STCG) that is taxed at the rate of 15 %.

And fund held for more than 1 year will be treated as Long term capital gain (LTCG), to be taxed at the rate of 10% for gains in excess of Rs 1 lakh in a financial year.

On the other hand, Short-Term Capital Gains (STCG) earned via short-term debt funds for a holding period less than 36 months, are taxed at the applicable rate as per your tax slab. And theLong-Term Capital Gains, i.e. gains made after staying invested for more than three years in case of debt mutual funds are taxed at 20% after opting for the indexation benefit.

Additionally, if one opted for the dividend option, the dividend declared by liquid funds carries effectively 28.84% Dividend Distribution Tax (including surcharge and cess).

In brief, the pros of arbitrage funds outweigh that of Debt funds (liquid funds):

Since the buying and selling of the same asset happens simultaneously, returns of these funds are highly predictable as compared toequity-oriented mutual funds

Ideal for parking money for the short-to-medium term-say for one to two years

A good alternative to keeping money idle in the savings bank account

The favourable tax treatment and hence are often attractive vis-a-vis short-term and ultra-short-term debt funds.

Hence from the past few months, the Asset Under Management (AUM) of Arbitrage funds has witnessed growth, as seen from the table below.

However, in terms of performance, the returns of top ten arbitrage funds have been lagging marginally as compared to the benchmark across various time periods. And the average category returns of arbitrage funds have been underperforming.

Thus, it indicates, there are hardly any outliers, which means, the performance of all arbitrage funds, irrespective of whos managing them, is the same.

An Arbitrage Fund is contingent upon market volatility, risk-free rate of returns and its ability to get access to real-time market data.

While market volatility and risk-free returns are the factors that are beyond the control of the fund; access to real-time data has become universal with the advent of sophisticated trading platforms making meaningful arbitrage opportunities hard to find. This leaves them with little margin for errors.

Besides, Arbitrage opportunities dry out under sideways market conditions, which is when the prices are range-bound, or during bear market phases when prices are usually moving down.

In the sideways markets, the spread, i.e. the differential between the cash market and derivatives markets, arent attractive enough for fund managers to take advantage of arbitrage opportunities that might exist.

And in the bear market phases, future market prices trade at a discount to cash market prices. As a result, arbitrage funds get fewer arbitrage opportunities.

When there arent many arbitrage opportunities, arbitrage funds invest a sizable corpus in short-term debt and money market instruments.

When there are ample arbitrage opportunities and markets are trending upwards, arbitrage funds tend to churn their portfolios frequently and under such circumstances, theexpense ratiosof arbitrage fund may shoot up.

Hence, if you have a time horizon of less than one-year, short-term debt funds like liquid funds/overnight funds may still be better options for you. Return potential of arbitrage funds is highly subjective to the market conditions.

To park money for the short-term (up to 2 years), you may consider an arbitrage fund. It makes sense particularly if you are in the 20% or 30% tax bracket.

Alternatively, you may consider short-term debt funds for an investment horizon of up to 2 years. But if you have an investment horizon of less than 1-year, low duration and money market funds would be the preferred choices.

And if you have an extremely short-term time horizon (of less than 6 months), you would benefit from investing inliquid fundsand ultra-short duration funds. Remember that investing in debt funds is not risk-free.

[Read:5 Facets To Look Into While Investing In Debt Mutual Funds]

In the current scenario where interest rates being reduced to curtail the inflationary pressures, shorter maturity papers look attractive, and fund houses, too, are aligning their portfolios accordingly.

However, make sure you have a clear objective in mind, know yourfinancial goals, risk profile, and the time horizon before goals befall before you invest your hard-earned money. Accordingly, you need to invest based on your personalised asset allocation.

Prudent investing and financial discipline are vital measures for long-term financial well-being.

PS:ConsiderPersonalFNs flagship premium mutual fund research service-FundSelect, if you want insightful guidance and recommendations on some worthy funds having high growth potential, in the years to come.

If you havent subscribed to FundSelect yet,you can do now!

This article first appeared onCertified Financial Guardian.

PersonalFNis a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailedTerms of Useof the web site.

Equitymaster requests your view! Post a comment onIs an Arbitrage Fund the right investment alternative solution to Short duration fund?.

Comments are moderated by Equitymaster, in accordance with theTerms of Use, and may not appear

on this article until they have been reviewed and deemed appropriate for posting.

In the meantime, you may want to share this article with your friends!Post another commentMore Views on NewsBSE Sensex at All Time High; INDUSIND BANK Among Top Gainers(Market Updates)Nov 7, 2019 Updated on Nov 7, 2019

The BSE Sensex is trading at its all – time high of 40,655(up 0.5 %).Among the top gainers in the BSE Sensex today are INDUSIND BANK. In the meantime, the NSE Nifty is trading at 12,011(up 0.4 %).

The BSE Sensex is trading at its all – time high of 40,597(up 0.3 %).Among the top gainers in the BSE Sensex today are INDUSIND BANK. In the meantime, the NSE Nifty is trading at 12,021(up 0.5 %).

PersonalFN explains whether it is beneficial to hold mutual fund units in demat account.

Stocks not part of the India story are unlikely to do well in the long run. Heres the ones you should avoid…

Is this the beginning of the end of multibagger gains in quality stocks like Nestle, HUL, and Asian Paints?

Infosys in a mess once again. Where is the stock headed next? Read this to know more.

After PI Industries, Hawkins has put up a stellar show so far.

Heres your chance benefit from a safe approach to making money in stock markets .

Tanushree is keen to reveal how you can make profits from safe blue-chip stocks.

A trend had changed the fate of few boring and beaten down stocks nearly two decades ago. And it may be back.

Please read ourTermsS&P BSE SENSEX40,653.740.45%

Since 1996, Equitymaster has beenthesource for honest and credible opinions on investing in India. With solid research and in-depth analysis Equitymaster is dedicated towards making its readers- smarter, more confident and richer every day. Heres why hundreds of thousands of readers spread across more than 70 countriesTrust Equitymaster.

Copyright ©Equitymaster Agora Research Private Limited.

Equitymaster Agora Research Private Limited (Research Analyst) 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai – 400 021. India.

Telephone: +91-22-61434055. Fax: +91-22-22028550. Email:.Website: CIN:U74999MH2007PTC175407

All rights reserved. Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

LEGAL DISCLAIMER:Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as Equitymaster) is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at ones own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA, Canada or the European Union countries, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an As Is basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to ourTerms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.