A Brief Note on Arbitrage Funds

The arbitrage fund category introduces an investor to an avenue to park their surplus funds. Typically, the arbitrage fund category predominantly looks forward to generating income through arbitrage opportunities between the price of a stock and its price in the futures market. 

During most market conditions, this difference, referred to as the spread, happens to be a reflection of the prevailing money market interest rates. Generally, these funds are considered an ideal investment vehicle for horizons over three months.

Conceptually speaking, arbitrage refers to an investment strategy where an investor simultaneously sells and buys an asset in various markets to take advantage of price differences and generate a profit. This price difference is termed a spread. So, the arbitrage fund category deploys such a technique to generate returns.

Liquid Funds vs Arbitrage Funds

While the suggested investment horizon in the arbitrage funds category is three to six months, the relatively less risky nature of these funds and the investment mentioned above horizon cause investors to face the dilemma of investing between liquid and arbitrage fund categories. 

However, the objectives of both these categories of funds are different in an investor’s portfolio. In case the investment horizon is a minimum of three months, an investor may consider parking their surplus funds in the arbitrage fund category. 

However, an investor could consider parking their surplus funds in the liquid fund category for an investment horizon of less than three months. Generally, the suggested investment horizon in such funds is seven to 91 days.

Taxation Factor

The Short-Term Capital Gains (STCGs), wherein the units held are for 12 months or less, of investments in the arbitrage fund category are taxed at 15%, like an equity-oriented fund. As a result, the post-tax returns of the arbitrage fund category tend to be more efficient than certain debt fund categories considered for parking surplus funds.

In addition, such tax-efficient returns in the arbitrage fund category become even more apparent when interest rates witness a spike. The reason is that since spreads in arbitrage markets reflect interest rates prevailing in money market instruments, the returns of the arbitrage fund category also tend to move in line with money market rates.