Arbitrage Funds: Low-Risk Hybrid Fund Investment

What is a Arbitrage Fund ?

An Arbitrage Fund is an open-ended, equity-oriented hybrid scheme that invests in equity market arbitrage opportunities.

Advantages of Arbitrage Funds

All-weather returns

Arbitrage funds have the ability to deliver returns in both bullish and bearish markets as they cash in on the price differential between spot and derivatives markets.

Portfolio diversification

Enjoy a diversified portfolio of equity arbitrage opportunities and get good returns on your investment.

Low risk

Arbitrage funds do not exhibit a high volatility risk despite investing in equity. This is because they invest in arbitrage opportunities, which are a hedge against risks.

Stable Returns

By profiting from price discrepancies, arbitrage funds can offer relatively consistent returns that are less dependent on the overall direction of the equity market.

Arbitrage Funds Returns Calculator

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Understanding Arbitrage Funds

Table of Contents

What are Arbitrage Funds?What are the features of Arbitrage Funds?What are the different types of hybrid funds?How do Arbitrage Funds work?What is the tax implication of Arbitrage Funds?What are the payout options?Who should invest in Arbitrage Funds?

What are Arbitrage Funds?

There are two types of equity markets - spot markets and derivatives markets. The price of an equity security differs in both these markets, creating arbitrage opportunities. Arbitrage Funds are equity-oriented hybrid funds which invest in these arbitrage opportunities and cash in on the price differential of the equity security under both the markets.

What are the features of Arbitrage Funds?

Minimum 65% allocation in equity arbitrage opportunities
The volatility risk is quite low, while returns are good
Suitable for all investment horizons
Invest through SIPs or lump sum
Earn tax-free returns up to Rs.1 lakh if you stay invested for 12 months or more

What are the different types of hybrid funds?

Aggressive Hybrid Funds

Funds that invest 65% to 80% of their portfolio in equity and the rest in debt

Equity Savings Funds

Funds that invest in equity, debt and arbitrage opportunities. A minimum of 65% of the portfolio is invested in equity and 10% in debt

Balanced Hybrid Fund

Hybrid Mutual Funds which invest 40% to 60% of the portfolio in equity and the remainder in debt

Multi-Asset Allocator Fund

Funds that invest at least 10% of the portfolio in three different asset classes

Conservative Hybrid Fund

Hybrid funds which invest 75% to 90% of the portfolio in debt and the remainder in equity

How do Arbitrage Funds work?

Arbitrage Funds collect investments from different investors and pool them into a corpus
Fund managers identify arbitrage opportunities in the equity market
Arbitrage opportunities are when the price of an equity security is different in the spot or cash market and the futures or derivatives market
For instance, a share trading at Rs 400 in a spot market and Rs 410 in a futures market creates an arbitrage opportunity
The fund manager can buy the security at Rs 400 from the spot market and sell it at Rs 410 in the futures market to make a profit of Rs 10
Depending on the profit made through arbitrage opportunities, the value of the portfolio rises
Risks are low since the price across the spot and futures market would differ even in a bearish market. Thus, fund managers can use this differential to make a gain

What is the tax implication of Arbitrage Funds?

Arbitrage attract equity taxation on the capital gains earned since they primarily invest in equity arbitrage opportunities
Returns up to Rs.1 lakh are tax-free if you stay invested for 12 or more months
Returns exceeding Rs.1 lakh are taxed at 10%
For redemption within 12 months, returns are taxed at 15%
Dividends earned, if any, are taxed at your income tax slab rate

What are the payout options?

Dividend option

Earn dividends on your investment at regular intervals
Growth option

Accumulate the returns over the investment tenure and get a lump sum amount on redemption

Who should invest in Arbitrage Funds?

New equity investors

You can benefit from the low volatility risk and enjoy stable returns
Investors looking to invest in equity

If you want to invest in equity at a reduced risk, the Arbitrage Fund will be a good choice.
Investors with a short-term investment horizon

If you want to invest for a short tenure, Arbitrage Funds can give better returns and tax efficiency than liquid funds

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FAQs On Arbitrage Funds

Arbitrage Funds make a profit based on price differentials in different markets. It is suitable for investors having a low-risk appetite who want to make profits in the short term from the volatile markets without taking too much risk.

Arbitrage Funds are low to medium risk investment which provides lower but stable returns compared to equity funds. The returns on Arbitrage Funds are determined by the arbitrage opportunities available in the market and the ability of the fund manager to capitalize on these opportunities. Arbitrage Funds generally tend to outperform liquid funds and FDs on average.

The risk factors of Arbitrage Funds are high expense ratios and unpredictable payoffs. Though these funds carry lower risk than pure-equity funds, it is affected by market volatility which may affect the price difference between futures and cash market thereby impacting the returns on the funds.
Arbitrage Funds are also affected by interest rate risk and credit risk. They are risky in the short run and may incur exit load if redeemed within one month.

Arbitrage Funds invest most of the amount in equity and equity-related securities and do well when the market is volatile. These funds are not suitable for aggressive investors as these funds provide lower returns compared to other equity funds. When selecting an Arbitrage Funds to invest funds, choose the one with a large corpus size, experienced fund manager and low expense ratio. You should also consider your investment horizon with a time of six months to three years before selecting an Arbitrage Fund. These funds are not meant for a long-term investment horizon of over five years.

Exit loads vary among different funds. Exit load is typically applicable on Arbitrage Funds if you redeem your investments before a specified period, i.e. within 15-30 days.