Arbitrage funds prove mettle

Standing by their mandate of stable performers in a volatile stock market, arbitrage funds have managed to hold on to their net asset value (NAV) over the last few days.

In the last one week, while the markets came down by nearly 5 per cent, equity mutual funds yielded negative returns of 7 per cent. However, most arbitrage and derivative funds saw positive returns.

As a category, these speciality debt schemes gave the best average return of 0.27 per cent between 25 July and 31 July, while the same for the diversified equity schemes stood at -4.22 per cent. 

DODGING THE VOLATILITY
Funds	Returns (%) (25-31 July)
SBI Arbitrage Opportunities	0.83
UTI Spread	0.71
Lotus India Arbitrage	0.68
Standard Chartered Arbitrage	0.68
ICICI Prudential Blended	0.68
JM Arbitrage Advantage	0.68
CATEGORY
Debt : Speciality	0.27
Equity : Diversified	4.25

All 20 funds in this category maintained their NAV and gave positive returns. Index funds were the worst performers during this period as they gave a negative return of 5.19 per cent.

Fund houses are seeing increased inflows for these open-ended arbitrage schemes, also known as market neutral funds, and few have even reduced their loading charges to attract bigger investments.

"We have seen very strong interest in our arbitrage funds. In fact, the corpus in equity and derivative fund has gone up by nearly 20 per cent in the light of recent market happenings," Sandeep Sabharwal, chief investment officer of JM Financial Mutual Fund said. The fund house lowered the exit load in its arbitrage advantage fund yesterday by 0.5 per cent.

"The premium of futures to cash keeps expanding and contracting in a volatile market and so there are a lot of opportunities for arbitrage funds to take positions. The transaction cost is not very big and so arbitrage funds give good returns in such a market," said Sabharwal.

Arbitrage funds typically take advantage of opportunities between the cash and futures market. The most commonly used strategy in the Indian markets is buy stock and sell futures and vice versa. Such opportunity arises when the price of a stock in the cash market trades at a discount against price of its future contract in derivative segment.

"You don't know where the market is heading. It is a good scheme for a bull market. Even in a bearish market, the returns are in line with liquid funds," said Sailesh Jain, fund manager-derivatives, Lotus India Arbitrage Fund.

A bullish market and a volatile market is normally beneficial for the arbitrage funds. When the market is performing well the fund grows but when volatility enters, these funds and exit at early stage and maintain their yield, which the equity schemes can not do.

However, analysts say if the market remains bearish over a time, that may not be the best time for the arbitrage funds. At present, most funds have good exposure to banking and auto stocks.

"Exposure to derivative investments was considered bit risky for fund managers. But, last few days more action is shifting to futures and options. Funds will be increasing their presence in this space and more products will come once the borrowing & lending mechanism comes through," said a fund manager with a leading private fund house.