Skip to main content

Arbitrage funds yield high returns in volatile markets

 

How these funds work for investors looking at relatively high returns in volatile conditions


   Arbitrage involves simultaneous purchase and sale of identical or equivalent instruments from two or more markets to benefit from a discrepancy in their prices. In arbitrage strategies, the buying and selling transactions offset each other thus building in immunity to market movements. So, regardless of stock market fluctuations, the fund will not get impacted.


   The profit in arbitrage strategy is the difference between the prices of the instrument in different markets. For example, cash and derivative markets. Though arbitrage funds are relatively less risky as compared to pure equity, they do have an element of risk.


   Arbitrage opportunities are good if the market is volatile. Arbitrage funds perform best in a volatile market. The higher the volatility, greater the arbitrage opportunity. Such funds are better-suited for investors who want low risk profile funds but expect decent returns. Fund managers hedge their risks by going long in the cash market and short in the futures market. These are safer as they always hold hedge positions and switch between cash and the futures options. Their risk profile is lower and regardless of market movement, the returns are good. Arbitrage funds are supposed to be market-neutral. Their return-potential depends on the arbitrage opportunities.


   One strategy includes buying stocks and selling futures. This arises when the price of a share trades at discount to the price of its future contract. Thus, one can buy the stock from the cash market at lower price and sell its future contract at a higher price, the profit being the difference between the future price and cash price. On or before the expiry date, the difference between the spot and futures price narrows. The position is then unwound to book profits. This happened in a few recent follow on public offers (FPOs).

Not quite risk-free    

Though arbitrage funds are referred to as 'risk-free' investments, this is not strictly true because there is some risk in availability of arbitrage opportunities and their timing. Arbitrage funds depend heavily on the availability of arbitrage opportunities in the market. A long bear phase may create problems because the arbitrage strategy of buy stock, sell future will not work if the future price of the stock is trading at a discount to its spot price.


   On the date of expiry, when the arbitrage is to be unwound, the stock price and its future contract may not coincide. There could be a discrepancy in their prices. Thus, there is a possibility that the arbitrage strategy gets unwound at different prices, leading to a higher or lower return. In addition to scarce arbitrage opportunities, margins tend to be low and expense ratios high as such funds trade heavily. Arbitrage funds are also impacted by lower liquidity in the spot/future segment.


   Future contracts are always traded in lots i.e. one lot of a future contract of a particular stock will have multiple shares. If an arbitrage opportunity arises, the fund manager will have to buy the lot shares of the company from the stock market and sell one lot of its future contract. The fund manager may not be able to purchase the desired number of shares at the given price.

Liquidity crisis    

Future contracts usually get squared-off automatically at the expiry date. But shares bought as part of the arbitrage strategy have to be sold before the market closes on the expiry date. If there isn't adequate liquidity in that stock, and all the stocks bought against its future contracts cannot be sold, it may cause losses. At the same time, the short position on its future contract must be squared-off, as it cannot be carried forward to the next month because of lack of opportunity.

Tax angle    

Since these funds are largely invested in equity, arbitrage funds attract a short-term capital gains tax of 15 percent. But if you hold it for more than a year, you are not liable to pay any tax. For tax purposes, arbitrage funds are treated as equity funds and enjoy lower tax vis-a-vis debt funds.

 

Popular posts from this blog

Mutual Fund Exit Load Changes

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300 Mutual Fund Exit Load Changes AMCs don't communicate about any change in exit load directly with investors, but do update on their website   The exit load applicable to your investments is the load which existed at the time when you invested in the particular fund. Any subsequent changes in the exit load will not be applicable to your investments.   However, Asset Management Companies ( AMCs ) periodically publish addendums in the newspapers, which state any change in exit loads of specific schemes managed by them. Such changes are also posted on their websites. However, a direct communication to an investor is not made, considering the costs involved in doing so. In their own interests, investors should not only track the performance of the funds they i...

Birla Sun Life Mutual Fund Launches Birla Sun Life NIFTY ETF

Birla Sun Life has launched a new fund namely, Birla Sun Life Nifty ETF, an open ended exchange traded fund. The new fund will be open for subscription from 4th July to 18th July 2011, at an offer price of Rs 10 per unit. The investment objective of the scheme is to generate returns that closely correspond to the total returns of securities as represented by S&P CNX Nifty, subject to tracking errors. No exit load will be charged under the scheme. The performance of the scheme will be benchmarked against S&P CNX Nifty and will be managed by Satyabrata Mohanty.   -----------------------------------------------------------------   Also, know how to buy mutual funds online:   1) DSP BlackRock Mutual Funds: http://prajnacapital.blogspot.com/2011/05/buying-dsp-blackrock-mutual-funds.html   2) Reliance Mutual Funds: http://prajnacapital.blogspot.com/2011/06/buying-reliance-mutual-funds-online.html   3) Birla Sunlife Mutual Funds: http://prajnacapital.blogspot.com/2011/...

Atal Pension Yojana contribution Tax Benefit for spouse

Contributions to Atal Pension Yojana (APY) are eligible for the same tax benefits as the NPS. This means that the contributions can be claimed under Section 80CCD (1B). The current limit for Section 80CCD (1B) is   Rs   50,000, over and above the   Rs   1.5 lakh limit under Section 80C. Section 80 CCD (1) is a different one, meant to cover employers' contribution towards NPS . You cannot get tax benefit by investing in the name of your spouse under Section 80 CCD . ------------------------------ ----------------- Invest Rs 1,50,000 and Save Tax under Section 80C. Get Great Returns by Investing in Best Performing ELSS Mutual Funds Top 10 Tax Saver Mutual Funds to invest in India for 2016 Best 10 ELSS Mutual Funds in India for 2016 1. BNP Paribas Long Term Equity Fund 2. Axis Tax Saver Fund 3. Religare Tax Plan 4. DSP BlackRock Tax Saver Fund 5. Franklin India TaxShield 6. ICICI Prudential Long Term Equity Fund 7. IDFC Tax Advantage (ELSS) Fund 8. Birla Sun Life Tax Relief 96 9. ...

Mutual Fund Reivew: Birla Sun Life Asset Allocation Conservative

Birla Sun Life Asset Allocation Conservative has numbers on its side to prove its credibility… Don't be surprised to find this Fund of Funds ( FoF ) in our recommendations. It has earned its place. And despite the difference in the structure of the product, there is no arguing with the numbers.   Of the total 6 years of its existence, the fund has been among the top 10 funds in its category in four of them. Last year it put up an average show and the only year it underperformed its peers was in 2008.   One aspect to look at when investing in an FoF is the expense ratio. The expense ratio of an FoF is capped at a lower limit of 0.75 per cent (2.50% for an actively managed fund). However, the FoF not only has its own expense (though lower) but even the expense ratio of the fund it is investing into. Fortunately, the fund manager takes that into account. "Expense is one of the important criteria used for fund selection and is the main reason for our investment in BSL Ind...

Short-Term Investment Options in Mutual Funds

Mutual funds offer liquid funds and ultra short term funds in the debt category, which are suitable for short investment periods. Ultra short-term funds were earlier known as liquid plus funds. Liquid funds invest in money market instruments with a maturity of 91 days or less. However, there are no such restrictions for ultra short-term funds. Who should invest in these? These are open-ended schemes. Investors with a short investment horizon or with surplus cash and low risk appetite should look at these. These could include corporate as well as retail investors. Those interested in staying invested for less than 15 days can opt for liquid funds. Retail investors who want to remain invested for two-four months, can look at ultra short-term funds. The short duration for both liquid and ultra short-term funds shields them from any interest rate volatility.   What kind of returns do they offer? In terms of an investment period less than 15 days, these funds are comparable to a ba...
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