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Friday, March 4, 2016

Tax Advantage for Arbitrage Funds

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Funds that have more than 65% allocation to equities are classified as equity oriented funds and hence dividend from them is tax free. IDFC Arbitrage and Arbitrage Plus funds fall in this category.

STT on equity oriented mutual funds is at 0.001%.

DDT on debt funds for Individuals is at 28.840% and for Non- Individuals is at 34.608%. For Dividend Option

Pre Tax*

DDT

STT

Effective Post tax

@

Debt Funds Return – Individual^

8.50%

28.84%

0.000%

6.05%

Debt Funds Return – Non-Individual^

8.50%

34.608%

0.000%

5.56%

Arbitrage Fund Return#

6.50%

0.00%

0.001%

6.50%

Note: The information provided above is as per prevailing taxation laws and applicable to Individuals/Non-Individuals who are Residents in India/Domestic companies respectively.

# For equity oriented funds, to avail Long Term Capital Gains (LTCG) benefit, holding period is 12 months from the date of investment. Securities transaction tax (STT) will be deducted on equity funds at the time of redemption and switch to the other schemes.

^For other than equity oriented funds, to avail Long Term Capital Gains (LTCG) benefit, holding period is 36 months from the date of investment.

@As per Finance Bill(2) of 2015.

*The returns mentioned above are just for illustration purpose

 

What is Arbitrage?

Buying in one market and selling in another simultaneously to take advantage of a temporary price differential is called arbitrage.

For instance, if you could buy A in Gujarat at Rs 100 and sell it in Mumbai simultaneously at Rs 101, you could make Re 1 profit at very low risk. This opportunity arises out of market inefficiency and is the basis of every arbitrage trade.

Cash-Futures Arbitrage

Since the cash market price converges with the futures price at the end of the month, you make a very low risk return of (101-100)*12/100 = 12% p.a.

This trade effectively captures the interest rate component in the equity futures market and does not involve taking any directional exposure to the equity market.

Factors influencing arbitrage potential

FII participation and their borrowing costs

FII ownership levels in specific stocks

Level of interest rates in the economy

Higher the retail participation , higher the spread and vice-versa

What should one be Aware of?

Arbitrage funds can be a good alternative to debt funds for investment horizon between 6–12 months.

 Monthly returns of Arbitrage/Arbitrage Plus funds tend to be volatile due to monthly expiry at different spreads. However, the returns tend to smoothen out as time horizon gets extended to 6months. Hence the ideal investment horizon should be 6months plus.

 There are periods when interest rates are low, and spreads are negative, the funds can give sub Liquid Fund returns. Hence we encourage investors to invest with a 6month plus horizon.

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