Lets dig in
arbitrage fund by understanding their Key Benefits.
funds rank high in pecking order when it comes to safety of capital. The
objective of the fund is to create market neutral position by buying a stock in
cash market and selling it in future market at same time.
equity market neutral investment approach of the fund makes it qualify for
equity fund like taxation which is much lower than the debt fund taxation with
comparable safety of capital.
funds perform better in volatile market conditions.
couple of years the arbitrage fund became a one of the most popular options
among the investor as an option for low risk investment due to its market
neutral investment approach along with tax efficient returns on investments.
Even in past couple of years the corporate treasuries in India invested in
these funds as an better alternative to liquid/ ultra short term fund ( on risk
parameters ) for tax efficient returns due to its equity taxation and lower
risk. The average category rolling period returns for one year holding period
are always positive.
Returns of Arbitrage Funds
Aditya Birla Sun Life Arbitrage Fund
ICICI Prudential Equity - Arbitrage
Nippon India Arbitrage Fund
Kotak Equity Arbitrage Fund
HDFC Arbitrage Fund
funds try to exploit the difference between the cash and derivative segment of
the equity markets for the same stock. The strategy of arbitrage fund is to
pocket the price difference of stock by creating buy and sell positions in cash
and future market simultaneously.
example, if any stock is trading at Rs. 1000 in the cash market and the
one-month future of same stock trades at Rs.1020 at the same time. The
arbitrage fund in such case will try to reap the price benefit by buying the
same stock in cash market for Rs. 1000 and selling one month stock future of
same stock for Rs. 1020 at same time to create market neutral position. On the
day of expiry (a future contract maturity day) the price of stock in cash
market and future market will intersect.
understand the Scenario I on day of
expiry in cash and future of the stock. The price of stock in cash market
(settlement price of the stock) is 1030 then the profit in cash market will be
Rs. 30 since the purchase price of stock was Rs. 1000 but in future market
there will be a loss of Rs. 10 since the selling price of stock future was Rs.
1020. In this trade there is a profit of Rs. 30 from the stock which was
purchased in cash market ( Rs. 1030 –
Rs.1000 = Rs. 30) and loss of Rs. 10 from selling of stock future ( Rs. 1020 –
Rs. 1030 = minus Rs. 10 ). Hence the profit from the trade will be Rs. 20 ( Rs.
30 Gain from Cash plus loss of Rs. 10 from Future trade ).
In another Scenario II if the cash price of stock
on expiry is Rs. 990 then there will be loss of Rs. 10 in stock cash price
since we bought stock for Rs. 1000 and the stock future position of stock will
make Rs. 30 since we sold the future at Rs. 1020 and now it is getting settled
at Rs. 990. The net gain in this trade will be Rs. 20 after adjusting the loss
of cash position of Rs. 10 against the profit of Rs. 30 in future position.
there are better arbitrage opportunities in volatile market conditions. Most of
the Arbitrage funds in India create a trade setup in one month future contract
which the keep on rolling every month for better liquidity. In volatile market
conditions the fund managers try to exploit the opportunities to reap the
profit from the trade before its expiry and reinvest in another trade. The
volatility in equity market creates many such churning opportunities for
arbitrage funds compared to the stable market conditions.
arbitrage funds irrespective of its investments in equity and equity derivatives
are independent of risk associated with equity market due to its market neutral
positions in cash and future market. Although there may be a interim volatility
in fund NAV ( Net Asset Value ) before the expiry due to marked to market of
positions held in cash and future market but this gets ironed out once the
positions are closed with targeted profit at the time of trade set-up. These
trades generally gets squared off on expiry or very near to expiry or at the
time of any profit booking opportunities available to avoid any impact cost on
NAV ( Net Asset Value ) of the fund.
always advisable to invest in Arbitrage funds with investment horizon of 3
Months to 6 Months.