Arbitrage funds should form some part of your debt portfolio because though returns are small, they are safe. In the last one year, when the stock marketshave been very volatile in patches, arbitrage funds have come into the limelight. During this time, when the equity markets lost over 50 per cent, these schemes did reasonably well by returning between slightly over 7.5 and 10 per cent (till January 7, 2009).
Unlike equity funds, these funds are slightly different in nature. Hence, they require a separate asset allocation.
Before you get into such schemes, it's important to look at the how these schemes operate and also, the part of the portfolio that should be allocated to them.
Typically, arbitrage funds follow a strategy of generating returns from the difference in prices in different market segments.
| ARBITRAGE FUNDS - ONE YEAR PERFORMANCE | |
| Scheme | Returns (%) |
| UTI SPrEAD | 10.19 |
| HDFC Arbitrage retail | 8.94 |
| J M Arbitrage Advantage | 8.81 |
| ICICI Pru Blended Plan A | 8.81 |
| Lotus India Arbitrage | 8.53 |
| Benchmark Equity & Derivative Opp | 8.05 |
| Kotak Equity Arbitrage | 8.01 |
| SBI Arbitrage Opportunities | 7.96 |
| IDFC Arbitrage | 7.63 |
| For the year ended January 7, 2008 Source : www.valueresearchonline.com | |
That is, there could be a price-differential in a share in the two stock exchanges – the Bombay Stock Exchange and the National Stock Exchange. Or, it can be between the cash segment of the market and the futures and options side. For instance, company A is trading at Rs 22 in the cash market and Rs 24 in the future market, an arbitrage fund will take advantage of this price mismatch.
Most of these funds actively use the cash versus futures route by taking a long position by buying the share in the cash market and an opposite position in the derivatives market.
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However, in circumstances where markets do not offer such opportunities, these schemes park themoney in debt options like term deposits or other short-term options like bank certificates of deposits (CDs) and commercial papers (CPs).
As far as returns go, since they try to make use of the arbitrage opportunities, returns depend upon the number of such options,besides returns from exposure in debt instrument.
That is why, returns are not very high by equity standards, but are mostly in the range of 6 per cent to 12 per cent.In terms of the investment and a part of the overall portfolio, an investor should ideally allot 5 per cent to 10 percent.
It is important to remember that returns from such funds are not spectacular, but there is a level of safety in them because of the investing strategy.
Since the buying and selling happens at the same time in different segments, there is no risk of a loss in the future because of fall in share prices. In other words, they are almost like assured returns products.
The main advantage of these schemes is that unlike equity schemes, they continue to provide some returns on a regular basis. Their exposure to debt instrument ensures that even in a tumultuous market conditions, the fund manager is able to take advantage of opportunities.
If the performance of these schemes is considered over the last one year then the returns have been on an average in the range of 8 per cent per annum. The period considered here is one-year time period ended January 7, 2008. Most schemes are likely to show a similar kind of return with not much difference between various top performing schemes.
Some of the schemes that have shows a higher return during this time period are UTI SPrEAD that has returned just over 10 per cent, while HDFC Arbitrage Retail, J M Arbitrage Advantage and ICICI Pru Blended Plan A have given returns in the range of 8.8-8.95 per cent.
Though like all other schemes, past returns are not indicative of future performance and this depends upon the arbitrage opportunities and the manner in which, a particular scheme exploits the opportunities.
If you want to have a portfolio strategy, one of the main time periods to consider an investment into these types of schemes is when there is likely to be large movements on either side or when the situation is uncertain. This is usually the time when arbitrage opportunities arise and benefits such schemes. The investment horizon should also be one year and above because this will help the investor realise better returns from the scheme.
The writer is a certified financial planner