Why investors are turning to arbitrage funds amid high stock valuations?
Synopsis Arbitrage funds are gaining traction among investors seeking equity exposure but wary of high valuations, with assets under management rising significantly. These funds capitalize on price differences between cash and futures markets, offering a market-neutral position and tax advantages. Attracting HNIs, family offices, and retail investors, arbitrage funds have delivered competitive returns with relatively low risk. Investors keen to allocate to equity, but uncomfortable with high valuations and eyeing a better entry point over the next 3-6 months, should consider arbitrage funds. The arbitrage fund category now manages assets worth Rs 2.85 lakh crore, up 36% from Rs 2.09 lakh crore in June 2024.
ADVERTISEMENT WHAT IS AN ARBITRAGE FUND? An arbitrage fund generates returns based on the price differential in the cash and futures market. The fund manager simultaneously buys a company in the cash market and sells an equivalent quantity in the futures segment thereby generating a return for the scheme. There is no naked exposure to any individual security or an index as each 'buy' transaction in the cash market has a corresponding sell transaction in the futures market. As per requirements, at least 65% of the corpus of the scheme is allocated to arbitrage products, while the fund manager is free to allocate the balance 35% between arbitrage or debt products, depending on his view on the market.
WHY ARE INVESTORS PUTTING LARGE CHUNKS OF MONEY INTO ARBITRAGE FUNDS?
There are investors who want to park money for a short period of time which is 3-6 months, either waiting for a correction in stocks or looking to earn more than a savings bank account. This, along with the tax benefits, where these funds are treated as equity funds for taxation, has attracted HNIs, family offices and even retail investors. Investors holding such schemes for less than a year pay 20% capital gains tax, while if they sell after a year, they pay only 12.5% long-term capital gains tax. As compared with this, in a debt fund, investors have to pay tax in line with tax slabs which is 30% plus surcharge for rich.
IS THERE ANY RISK FOR INVESTORS IN ARBITRAGE FUNDS? Arbitrage funds rank high on safety. The scheme always has a market-neutral position by buying in the cash market and simultaneously selling the same security in the futures market. Compared with debt funds, where there could be some credit risk, there is no such risk here. As indices clock all-time highs and more investors turn to the stock markets, there is increased participation from institutional and retail investors in the futures and options segment, leading to higher volatility and demand for money. That, in turn, pushes up returns in these schemes.
ADVERTISEMENT WHAT RETURNS HAVE ARBITRAGE FUNDS GENERATED IN THE LAST ONE YEAR? Over the last one year, data from Value Research showed arbitrage funds generated 6.55% returns.
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