Rising share of arbitrage funds in futures segment weighing on returns

Estimates suggest such funds account for over half of stock futures segment

The rising share of arbitrage funds in the futures segment is making it difficult to generate optimum returns. Such funds now account for over half of the futures’ segment open interest (OI).

According to data collated by Capitalmind, arbitrage funds accounted for 51 per cent of single-stock futures’ OI at the end of June, when total futures contracts for the near-month had an OI of Rs 93,663 crore.

Experts say the recent weakness in returns could be attributed to these funds now being the largest players in the single-stock futures segment.

“This creates the biggest-player problem. If you are the only elephant in the room, any move you make is noticed by other market participants,” says Deepak Shenoy, founder and chief executive officer of Capitalmind Wealth.

“Other players are aware that arbitrage funds have to rollover towards the end of the month, i.e., buy back the June future and sell the July future. So, a number of July future contracts show a discount and trade lower than June contracts,” he added.

However, fund managers say we need to assess whether this is a temporary issue because of higher market volatility or a structural problem. “We must remember that heightened market volatility has also played a part in disrupting future spreads,” said a fund manager.

Arbitrage funds as a category saw strong growth in the previous financial year, as investors sought pockets of safety with credit risks taking a toll on debt schemes. Since the beginning of the last financial year, the asset base of arbitrage schemes has risen about 71 per cent — from Rs 50,839 crore to around Rs 87,000 crore in February.

 

 

Experts say arbitrage funds have also found it difficult to generate returns amid low rates in the debt segment.

“Arbitrage funds can make up for lower spreads by investing part of scheme assets in shorter-term debt papers. But, the yields at the shorter-end of the curve have been on the lower side,” said Vidya Bala, co-founder of primeinvestor.in. In the one-month period, the returns from arbitrage funds were marginally in the negative.

The weakness in returns has led to concerns among investors. As a result, flows in the category have been volatile over the past few months. In March, the category saw net outflows of Rs 33,767 crore, and in April and May, the category garnered net flows of Rs 17,393 crore.

Arbitrage funds had also come under pressure earlier in the year with future prices trading at a discount to spot market prices, amid heightened volatility. Some fund houses had temporarily suspended fresh flows into their arbitrage schemes.

Advisors say investors can still consider arbitrage schemes, but with a longer time horizon. “Investors need to be wary as we have recently seen how sharp volatility in the markets can also impact arbitrage scheme returns. The schemes are suitable for investors looking to park funds for 6-12 months,” said Rushabh Desai, an MF distributor.