Skip to main content

Arbitrage Funds - Risk Fee Earners

Of late, there has been an avalanche of bad news flowing out of the Indian stock markets. The Sensex tottering around the 14K mark, the Nifty around the 4K mark, the plummeting stock prices of most companies, mutual funds failing to garner any positive returns... the list seems to go on and on, and on. Amidst all of these sob stories, we have become almost desperate for some positive information. Well, look no further.



While the markets have been crashing around us, there has been one category of mutual funds that have actually generated returns in the green. They are the Arbitrage Funds. Quite often referred to as equity-and-derivative funds, arbitrage funds are an ideal way of earning a reasonable income from equities with the modest amount of risk, And here's how.



The objective of an arbitrage fund is to capitalise on a stock's price difference between the spot market (cash segment) and the derivatives market (futures & options segment).



These funds basically generate income by taking advantage of the arbitrage opportunities arising out of the mis-pricing between the two markets (spot and derivative).



Let's illustrate this concept with a hypothetical situation. Let's suppose that the stock of Company XYZ is trading at Rs. 500 in the spot market. Simultaneously, the stock is also being traded in the derivatives market where the stock future is priced at Rs. 510. Now, when an arbitrage fund manager sees such a mis-pricing, he sells a contract of the XYZ stock future at Rs. 510 and buys an equivalent number of shares at Rs. 500 from the cash segment. In this way, he earns a risk-free profit of Rs. 10 per share (minus relevant transaction costs). The best part about such profit earnings is that they can come irrespective of the overall market movement.Furthermore, on the settlement day of the derivatives segment, the stock prices in both the markets tend to coincide. So, the fund manager will reverse his transaction - buy a contract in the futures market and sell off his equity holdings in the spot markets - and earn more profits. An arbitrage fund carries out a number of such transactions to generate favourable returns.



Sounds highly appealing, doesn't it? Well, arbitrage funds have clearly outperformed debt funds and the returns of an arbitrage fund become tax-free after a year, but these funds have a few concerns as well. The main concern would be a bloating asset size. If the AUM of an arbitrage fund increases heavily, then a majority of the assets would remain parked in money market instruments simply because of the lack of enough arbitrage opportunities. However, it is not time to be overly concerned as yet because more and more stocks are being introduced in the derivative markets, hence broadening the investment universe for arbitrage funds.



So, should you opt for an investment in arbitrage fund? The facts and figures sure support the cause. Arbitrage funds offer better returns than debt or income funds and their earnings become tax-free after a year. But, increasing assets could be a cause of concern, albeit not yet. The category currently manages a moderate amount of assets and is made up of 10 funds. But the deciding factor could be that arbitrage funds generally thrive on volatility. The higher the volatility in the markets, the higher is the potential of mis-pricing between the spot and derivatives markets. Hence, at a time like now, when the markets are at their volatile best, arbitrage funds might just turn out to be the most favourable form of investment.

Popular posts from this blog

Rs 14,000 Crore worth of tax free bonds coming soon from NHAI , PFC

  NHAI, PFC file prospectuses, coupon rate not yet decided MORE debt investment options have opened up for investors with AAA rated tax-free bonds worth over Rs 14,000 crore lined up. The National Highway Authority of India ( NHAI ) and Power Finance Corporation ( PFC ) are offering Rs 10,000 crore and Rs 4,033.13 crore worth of tax-free bonds, respectively, as per prospectuses filed with the Securities and Exchange Board of India (Sebi). Of a Rs 5,000 crore issue by PFC, Rs 966.87 crore has already been raised through private placement on September 28 and November 1. Tax-free bonds give investors tax-free return on any amount invested. In another kind of bonds, the long-term infrastructure bonds, investments up to Rs 20,000 are tax exempt, that is this cap amount can be deducted from the taxable income. Accordingly, the NHAI prospectus has clarified that only the amount of interest from -and not the actual investment on -its new bonds will be tax-free. "NHAI's publ...

Change in Fund Manager for some of HSBC Mutual Fund Schemes

Buy Gold Mutual Funds Invest Mutual Funds Online Download Mutual Fund Application Forms Call 0 94 8300 8300 (India) However, this facility is only available to Unit holders who have been assigned a folio number by the AMC.   HSBC Mutual Fund has announced that the below mentioned schemes shall be managed by the new fund managers as stated in the table. The effective date will be July 02, 2012.   Amaresh Mishra 's will be Vice President and Assistant Fund Manager. Having done a Post graduate diploma in Business Management and Bachelor of Chemical Engineering, he has over seven years of experience in Equities and Sales.   Mr. Piyush Harlalka's designation shall be Vice President- Fixed Income. Qualified as a C.A., C.S. and holding M.B.A.( Finance degree), he has over six years of experience in Fund management and ...

How EEE and EET Tax affect Retirement Investments

  An important factor while choosing a financial product is its taxation , and for retirement savings, this is even more important as the sums involved are usually life-long savings. Here's a look at the current tax treatment of three major long-term retirement planning products, which are - Employees' Provident Fund (EPF), Public Provident Fund (PPF) and National Pension System (NPS). EPF The tax treatment is EEE, which means your money is exempt from taxes at the time of investment, accumulation and withdrawal. At the time of investment, the tax deduction is under the limit of section 80C of the Income-tax Act , which is currently Rs 1.5 lakh. Partial withdrawals are also tax-free if made after 5 years of continuous service. If withdrawals are made before 5 years of service, 10% tax will be deducted at source. Exceptions have also been provided for transfer of amount and conditions wherein the subscriber is unemployed for more than 2 months or the loss of job was beyond th...

Personal Finance: You can insure your wedding

But luck may not always be on your side. With the frequency of such attacks, as also other risks and unforeseen accidents growing, a wedding insurance is something you may want to look at if a marriage is being planned in the family. Event insurance plans like this is still in its nascent stages due to low awareness. And given the sacred nature of the ritual, nobody wants to discuss or think negative. But as wedding spends and risks grow, it makes sense to cover the potential monetary loss. The policy in those countries even covers the loss of the wedding ring, the wedding gown not reaching on time and even the expenses/loss due to late or non-appearance of the photographer which may mean staging the event once again for the photograph. In India, most insurance companies — including ICICI Lombard General Insurance, Oriental Insurance, Bajaj Allianz and National Insurance — offer wedding insurance. The policy is tailor made to individual requirements and needs. The sum insur...

DSP BlackRock MidCap Fund

Best SIP Funds Online   HOW HAS DSP BlackRock Small & Mid Cap Fund PERFORMED? With a 10-year return of 14.61%, the fund has outperformed both the category average (12.34%) and the benchmark (10%) by a good margin. Should you invest in DSP BlackRock Small & Mid Cap Fund? This fund invests predominantly in mid-cap stocks but takes a sizeable exposure in small-caps as well. The focus is on nascent companies with high growth potential. The fund manager places emphasis on quality and avoids inferior businesses even if these look tempting from a valuation perspective. Over the past year, the fund portfolio has grown, having added to some of the underperforming sectors like chemicals and healthcare. Its portfolio churn has come down significantly. The heavily diversified portfolio is run completely agnostic of its benchmark index— most bets are from outside the index—which can at times lead to bouts of underperformance as seen in the recent years....
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now