What are Arbitrage Funds?
Arbitrage Fund is a type of equity mutual fund that capitalizes on the mispricing between the cash/spot market and derivatives/futures market. In simple words, it refers to taking advantage of the difference in pricing in two markets at the same time.
How does Arbitrage Fund work?
1. This fund works on the principle of buying at a lower price in one market and selling at a higher price in another market to make profit. Say, a company's stock is trading at Rs 500 in the cash market and at Rs 550 in the futures market. So, Rs 50 per share is the profit an investor can make by buying stock in the cash market and simultaneously selling it in the futures market.
2. Exiting the funds prematurely involves a nominal penalty, usually 0.25-0.5% in the first three to six months as compared to 1% in case of bank FDs.
3. Arbitrage funds can be redeemed in three working days.
Who should invest in Arbitrage Fund?
1. It is perfect for the investors with a lower risk appetite as it is the safest option in the time of volatility. The arbitrage opportunities exist only when the markets are unstable and uncertain.
2. Those who want to stay invested for medium to long term.
Why should one invest in Arbitrage Fund?
1. Safe option to park money when there is persistent volatility in the market.
2. Returns are likely to be much higher than investment in savings account. The fund managers reduce the risk of equities by hedging against the derivatives.
Arbitrage Fund and Taxation
Since arbitrage funds maintain an average exposure of more than 65% to equity, they are treated as equity funds, their holding period for long-term capital gain is one year.