Arbitrage Funds are a type of mutual fund that seeks to exploit price differentials between related financial instruments in various markets. The goal of these funds is to generate returns by taking advantage of temporary mispricing or price differentials between assets.
The primary strategy employed by arbitrage funds involves simultaneously buying and selling assets in different markets or forms to capture the price differential.
The most common form of arbitrage involves buying an asset in one market where the price is perceived to be undervalued and selling the same or a related asset in another market where the price is considered to be overvalued. The process involves capitalizing on the price differential while minimizing market risk.
Key features of arbitrage funds include:
Low-Risk Profile: Arbitrage funds are generally considered low-risk compared to other equity-oriented funds because they aim to capitalize on market inefficiencies rather than market direction. They often have a more stable return profile.
Equity and Derivative Components: Arbitrage funds typically invest in a mix of equity stocks and derivative instruments such as futures and options to execute their arbitrage strategies.
Tax Efficiency: In some countries, including India, arbitrage funds enjoy certain tax advantages. In these regions, the tax treatment of gains from arbitrage funds may be more favorable compared to other equity-oriented funds.
Short Holding Periods: Arbitrage opportunities are often short-lived, and these funds may have a relatively short holding period for their positions. The funds frequently engage in frequent trading to capture these fleeting opportunities.
Market-Neutral Approach: Arbitrage funds aim to be market-neutral, meaning they seek to balance long and short positions to minimize exposure to overall market movements. Their returns are expected to be more dependent on the success of their arbitrage strategies rather than broad market trends.
It's important to note that while arbitrage funds are generally considered lower risk, they are not risk-free. Market conditions, transaction costs, and regulatory changes can impact the effectiveness of arbitrage strategies.
Recently, arbitrage funds are yielding more returns than liquid funds — and they come with better tax treatment. It is no wonder, therefore, that savers are buying into this asset class, with assets under management (AUM) climbing 60% in a year to Rs 1.38 lakh crore.
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