Best Arbitrage Funds To Invest In India: Benefits & Taxation Of Arbitrage Mutual Funds

Mutual funds

Arbitrage funds are a type of mutual fund which invests mainly in equities and allows an investor to purchase and sell securities in various markets. It is a hybrid fund that gains profits through price differentials in the market. 

The mutual funds market is known for its volatility, however, it’s also one of the most high-returns generating investment options. Arbitrage mutual funds capitalise on price differentials, like the difference in cash pricing or futures market.  

So, rather than waiting for your purchase to gain value, your fund manager will buy stock in the cash market and then sell it in the futures market. Buying arbitrage funds in India is a good way of making profits in a volatile market without taking many risks.

5 Best Arbitrage Funds in India

How does Arbitrage Mutual Funds Work?

Arbitrage mutual funds work on the gap in the pricing of equity shares between the current and futures market leveraging higher returns. Here a fund manager consistently buys shares in the cash market to make a later sale in the derivatives market. 

Working of an arbitrage mutual fund can be explained through the following example:

XYZ Company has equity shares which the company trades in the stock market for Rs 1,220 and in the derivatives market at Rs 1,235. Now the fund managers buy the XYZ Company’s shares from the stock market and form a contract to sell it at Rs 1,235 in future. Once the prices coincide at the end of the month the fund manager will sell the shares in the futures market and earn a risk-free profit. 

However, if the fund manager notices that the prices are falling in the future then he or she can choose to enter in a long term contract and choose to sell it once the prices coincide again. 

Avenues Where Arbitrage Funds Invest Your Money

A fund manager buys shares from the stock market and simultaneously sells them in the futures market. Typically, these funds invest 65-100% in equity assets and 0-35% in debt asset classes.

Who Should Invest in Arbitrage Funds in India?

Arbitrage funds are like debt funds when it comes to their risk profiles. They gain what is called an arbitrage profit by leveraging the market inefficiencies. Many of these funds in India use the Crisil BSE 0.23% Liquid Fund Index which you can use to keep track of performance. 

If you want to invest in equities but do not want to bear the risks, the best arbitrage mutual funds are for you. It gives an investor a chance to park their surplus funds safely in a constantly fluctuating market. 

These funds are most beneficial for investors who are looking for short or medium-term financial gains. However, a fund manager will only invest your money when there are definite opportunities to earn returns. 

Also Read: Balanced Mutual Fund

Features of Best Arbitrage Mutual Funds

The features of some of the best arbitrage mutual funds are:

• Suitable for an investment period of 1-3 years
• Offers more tax-efficient returns compared to fixed deposits due to equity taxation
• The fund manager is already aware of the cost price and selling price so there is no stock market risk involved 
• investors can choose the investment route i.e. if they want to invest in lump sum or SIP. 

Why Should You Invest in Arbitrage Funds?

1. Low-risk

The prime benefit of investing in these funds is that they involve low risk. As per historic data, these funds could perform well when the market fluctuates. Also, as the securities are being bought and sold simultaneously, there is no possible long-term risk involved as well.

2. Has the potential to perform well in a volatile market

Unlike other low-risk securities, these funds could flourish in a highly volatile market. This is because fund managers can take advantage of significant fluctuations in individual stocks through buying/selling. 

3. Taxed as Equity funds

The portfolio of arbitrage funds in India consists of 65% equity funds; thus, they are taxed like equity funds. So, if you keep your shares in these funds for more than one year, the profit will be taxed at a capital gains rate, which is much lower than the income tax rate.

Taxation on Arbitrage Funds

Although classified as a hybrid, Arbitrage Mutual Funds are treated as equity funds while taxation. Investors who hold such schemes for less than 12 months are taxed under 15% capital gains. However, if these investors sell these shares after a year they will only be taxed 10% of capital gains. 

In the case of debt funds if an investor sells his or her funds before three years then the gains will be added to one’s income and taxed as per the income tax slab. 

How to Select the Best Arbitrage Mutual Funds?

Investors should look for the following essential elements while choosing the best arbitrage mutual funds:

• The performance of funds compared to other similar funds
• Percentage of debt and equity based on risk appetite
• Provides downside protection
• Stability in terms of returns 

What are the Risks Associated with Best Arbitrage Funds?

Arbitrage mutual funds are popular because they provide a low-risk environment to investors as fund managers are simultaneously buying and selling shares. However, risk arises when the markets are trading flat and opportunities tend to become scarce. In these cases, arbitrage funds generate lower or below-average returns. 

Another risk involved in arbitrage mutual fund investments is credit risk. Since arbitrage mutual funds are hybrid funds they invest a small number of assets in debts. These investments are made in the form of term deposits or very short term debt. This results in incurring interest rate risks and credit risks. 

How to Invest in Best Arbitrage Mutual Funds?

Individuals can invest in arbitrage mutual funds via both online and offline modes. In the case of an offline method, the investors can visit an AMC or financial institution. There a fund manager will guide the individual through the entire process. 

On the other hand, in an online method individuals can take the help of various financial institutions’ websites. There one needs to create an investment account. Then fill up the required details and submit all the KYC documents. 

Factors to Consider Before Investing in Best Arbitrage Mutual Funds

1. Financial Goal

It is important to go through a fund’s investment objective to ensure that these align with your financial goal. Arbitrage funds in India are a great option for those investors who have excess funds and want to make short to medium-term profits. 

As these funds offer high profits when the market is volatile, it is considered better to invest a lump sum amount. When price differentials are favourable, you can also transfer your investment from equity funds to arbitrage funds in India. 

2. Returns on Investment and Risks

Arbitrage funds are known for having low risks because the fund manager buys a stock in a market and immediately sells them to another. But the chances of finding good price differentials are few; thus, the investments aren’t as impressive as other funds. These funds attract those investors who are looking to make average returns and take low risks. 

3. Expense Ratio

Fund houses charge a certain amount every year from investors to manage their mutual funds. This expense ratio is a percentage of assets that the fund manager charges. 

As a fund manager conducts multiple transactions every day for arbitrage funds, their fees can be quite high. Even the exit and entry load can be hefty for these funds. Thus, you should review these costs before investing. 

Also Read: Overnight Mutual Funds

Arbitrage Fund Manager’s Role

Arbitrage fund manager plays the following vital roles:

• They are responsible for buying and selling the shares on behalf of the investors
• Fund managers have the power to decide whether they want to sell the shares in the futures market or not. When shares are not performing well they can choose to get into a long term contract and wait for the prices to coincide for better returns. 
• Further, these managers also help in creating “Alpha” or excess returns for their investors.

Final Word

The low-risk strategy offered by arbitrage funds in India has been appealing to investors. They are amongst the few mutual fund schemes that actually show gains when the market is volatile. Their payoff is unpredictable, but risk-averse investors, are the best schemes to generate returns. 

In case you want to explore the power of passive investing, you can start investing with Navi Mutual Fund. With Navi Mutual Fund, you get to explore a wide range of low-cost index funds.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

FAQs on Best Arbitrage Funds in India

Before you go…

Want to put your savings into action and kick-start your investment journey 💸 But don’t have time to do research? Invest now with Navi Nifty 50 Index Fund, sit back, and earn from the top 50 companies.

Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.