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In India, Arbitrage Funds started gaining popularity in 2014. Today, many investors, especially first-time and inexperienced investors looking for risk-free returns on their investment, invest in Arbitrage Funds. After the Budget 2014 was presented in the Parliament by the then Finance Minister of India, Late Mr. Arun Jaitley, he changed the taxability of debt funds. In 2014, the tax benefits associated with debt funds were taken away.With debt funds no longer offering tax benefits, many smart investors have now started investing in arbitrage funds as a means to earn risk-free and tax-free returns.
What is Arbitrage Mutual Fund?
The term arbitrage essentially means buying the securities in one market and selling the same in another market to leverage the benefit of the price difference in the units of the securities in different markets. Since buying and selling happen simultaneously in such trades, there is no scope of time risk of the price fluctuations. And, therefore, such trades are known to be risk-free. It is important to note that the difference in the purchase and sale price is only marginal and, therefore, the profit margin is not too high.The fund managers buy shares from one market and sell them in another market to take advantage of the difference in these shares' prices. They also buy in the cash market and sell in the futures market and earn profits through such arbitrage. Since the profit in such trades is less on each trade, the fund managers carry out several trades every year to earn a decent profit.
Tax Implication on Sale of Arbitrage Mutual Funds
Arbitrage funds invest a significant portion of the investment in equity shares and other equity-related securities. Therefore, they are a part of the equity mutual funds, and they are taxed accordingly. These funds get the tax benefits that are available to other equity mutual funds.If you hold the funds for more than one year, then the income is known as long-term capital gains (LTCG), and a tax rate of 10% is applicable (with effect from the financial year 2018-19).If you hold the fund for less than a year, then it is a short-term capital gain, and a tax rate of 15% is applicableIn the case of LTCG, you can get tax benefits up to a maximum limit of Rs. 1 lakh per year. This means if you earn a profit of Rs. 1.5 lakhs in a year, then you are liable to pay a tax of Rs. 5000 only.Owing to the tax benefits associated with arbitrage funds, many tax-conscious investors consider arbitrage funds a safe investment to save their taxes and get risk-free returns.
Returns Potential of Arbitrage Mutual Funds
Usually, the difference in the prices of securities in two different markets is less. Therefore, the arbitrage mutual funds enter into several transactions every year to capitalize on the price difference and earn a decent profit. Additionally, as the buying and selling of the securities happen simultaneously, there are zero risks as the securities are already sold.Although arbitrage funds do not guarantee returns, these funds have historically provided returns in the range of 8-10% every year. When the market condition is unstable, there are more arbitrage opportunities, and therefore the profits tend to be higher when the market volatility is high. The higher the market volatility, the higher the returns potential, and vice-versa.
Comparing Investment in Arbitrage Funds with Investment in Fixed Deposits
In India, the fixed deposit is one of the most secure investments. A lot of investors who look for risk-free returns prefer investing their hard-earned money in FDs. But is it the best investment? What is its returns potential? Let us understand this with the table below:
|
| Fixed Deposit | Arbitrage Funds |
| ROI (Returns on Investment) | 4% to 6% (fixed at time of opening the FD account) | 8% - 10% (expected returns) |
| Tax applied on the returns earned | 30% | If the fund is held for less than one year – 15% If the fund is held for more than one year – 10% |
| Net returns after tax deduction | 3% - 4% | 8% to 10% |
| Level of understanding | Fixed deposits are easy to understand. You need not have any knowledge about the market to invest in FDs | Arbitrage funds can be a little difficult to understand. You must have a good understanding of the working of mutual funds and the market conditions to make informed investment decisions. |
| Ideal Investment Opportunity For | FD is an ideal investment for people who are looking for 100% safety and guaranteed returns. | Arbitrage funds are an ideal investment for people looking for a short-term investment opportunity with tax-free returns and get higher returns than a savings bank account. |
Please Note – The above chart is prepared based on the assumption that you belong to the highest income-tax bracket
Arbitrage Funds – Is it Worth Investing?
If you belong to the highest tax slab, i.e., 30%, it is wise to invest in arbitrage mutual funds instead of FDs as you can get better returns on investment. However, if you fall in the lower tax bracket, you can still get better returns from arbitrage funds compared to FDs.
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.
