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The term arbitrage indicates simultaneously buying and selling of securities in different markets to leverage the market volatility and price difference of the same assets to generate returns. Arbitrage fund is a type of equity mutual fund that invests primarily in buying equity and equity-oriented funds.Typically, the fund managers purchase arbitrage funds in the cash market and sell them in the futures markets to earn maximum returns from the difference of the prices in both the markets.Let us understand how the arbitrage funds work with an example.Let us assume that the share price of a certain company is quoted at Rs. 100 in the cash market and Rs. 105 in the futures market. The fund manager will purchase the stocks in the cash market and simultaneously sell them in the futures market and thereby earn a risk-free profit of Rs. 5 per share.The arbitrage fund works well when the market is volatile as the fund managers can capitalise on the price difference of stocks in different markets.Apart from being an excellent investment option when the market is unstable, these funds historically are known to generate higher returns (approximately 8%), which is much higher than the traditional investment options like fixed deposits and savings bank accounts. Not to mention,taxation arbitrage fund is another reason why it is popular among investors.The table below compares arbitrage funds with fixed deposits and savings accounts on different parameters. It will give you a fair idea why arbitrage funds are a better investment choice than others.
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| Arbitrage Funds | Savings Account | Fixed Deposits |
| Investment Returns (%) | 7-9 | 3-5 | 5-7 |
| Tax on returns earned | If the investment is held for more than one year, the returns are tax free. If the investment is held for less than one year, the returns are taxed at 15% | 30.90% | 30.90% |
| Ideal Investment for | People looking to invest for one to two years to get tax benefits and better returnsthan traditional investment instruments. | People looking to keep their surplus income safe and secure and get moderate but risk-free returns. | People looking for short-term to mid-term investment options that do not carry market risk. |
| Complexity | Investing requires knowledge of the market functioning. It can be complicated for a layman to understand the working of these funds. | It is easy to understand. | Easy to understand for all. |
Note – The above chart is for illustrative purposes only and it is prepared assuming that the investors fall in the highest tax slab.
Arbitrage fund taxation
Since arbitrage funds are categorised as equity funds, they are taxed accordingly. This gives arbitrage funds the benefit of zero taxes on the LTCG (long-term capital gains). If you hold the investments for more than one year, the returns are considered to be LTCG, and are tax free. But, if you withdraw the investment before one year, the returns are considered to be STCG (short-term capital gains) and are taxed at 15%.
DISCLAIMER
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.