In the world of investing, the holy grail is high returns with low risk. We all want to earn the premium that equities provide, but without suffering the volatility that comes with them. Arbitrage funds allow you to do exactly that.
These funds aim to capture the arbitrage opportunities present in the cash and derivatives market segments.
What is Arbitrage and How Do Arbitrage Funds Work?
Arbitrage refers to the simultaneous buying and selling of the same security in different markets to take advantage of the price difference. Arbitrage opportunities exist because of market inefficiencies.
Arbitrage funds work on the principle of arbitrage. They buy securities in one market while selling them at a higher price in another. The fund pockets the difference in prices. This allows them to earn potentially low-risk returns that are similar to equity returns over the long term.
For example, an arbitrage fund can buy stock futures when they are at a lower price compared to the underlying cash market. It will then sell the more expensive cash market shares and pocket the difference. The steps are:
- Spot Buy: Buy shares of Company ABC on the spot market at ₹ 500.
- Futures Sell: Sell the future contract of the same stock at ₹ 510.
- Wait for futures expiry: when the futures price will converge with the spot.
- Spot Sell: Square off the spot position at ₹ 510, earning ₹ 10 per share.
By doing this repeatedly, arbitrage funds are able to earn steady, low-risk returns that outperform debt funds. The risk is low because securities are bought and sold at the same time.
Some key features of arbitrage funds:
- Low Risk: Despite exposure to equity markets, the risk level is low as securities are bought and sold at the same time.
- Low Volatility: Negligible price risk makes them less volatile.
- Uncorrelated returns: Returns have a low correlation with equity and debt assets.
Overall, arbitrage funds provide equity-like returns with debt-like low volatility. Making them an attractive investment to have in one’s portfolio.
Why Invest in Arbitrage Funds?
Here are some key reasons why arbitrage funds make for a good investing option:
- Higher Post-tax Returns: Arbitrage funds come under the equity funds category for taxation purposes. This allows them to enjoy a lower 10% tax on LTCG over ₹1 Lakh compared to 20% for debt funds. This makes them tax-efficient.
- Low-Risk Strategy: The market-neutral nature of arbitrage makes the strategy less vulnerable to equity market movements or volatility. The risk of losing capital is comparatively minimal.
- Diversification Benefits: Due to the low correlation between equity and fixed income, arbitrage funds aim to improve overall portfolio returns while decreasing their volatility when added to a balanced portfolio mix.
- Liquidity: Easy liquidity makes arbitrage funds perfect even for short-term parking of funds.
Why Consider Bandhan Arbitrage Fund?
Bandhan Arbitrage Fund is a hybrid fund focusing exclusively on arbitrage opportunities. Since its launch in June 2020, Bandhan Arbitrage Fund aims to deliver returns with low risk.
The fund achieves this by dynamically managing arbitrage opportunities across sectors and market capitalizations.
Conclusion
Arbitrage funds present investors with a suitable opportunity to earn equity-linked returns with potentially minimal risk. As markets reduce classical arbitrage opportunities more efficiently, exposure to professional arbitrage funds in one’s portfolio looks increasingly prudent.
