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The arbitrage funds' business has more than doubled in the past six months on the back of near double-digit returns and tax advantage.
Arbitrage fund is a type of mutual fund that tries to exploit the price difference of an asset between two or more market segments. It has the risk profile of a debt fund, but gets taxed as an equity fund, making it attractive for short-term investors. Arbitrage funds work well in volatile markets as fund managers are able to capitalise on the differences in prices of a stock between the equity market and the futures market. Arbitrage fund managers reduce the risk in equities by using derivatives to hedge them.
These funds' business rose 139 per cent to Rs 29,000 crore at end-July from about Rs 12,100 crore six months ago. JM Arbitrage is the largest scheme in this category, with a business of Rs 5,800 crore. Kotak Equity Arbitrage, ICICI Prudential Equity Arbitrage Fund, IDFC Arbitrage, Reliance Arbitrage Advantage, and SBI Arbitrage Opportunities, have a business of over Rs 1,000 crore each.
"After the change in tax norms in the past year's Budget, practical rich investors shifted from short-term debt funds to arbitrage funds. So, the category has not expanded the investor base. It's only the existing investors who moved," said Manoj Nagpal, chief executive, Outlook Asia Capital.
"Investors in liquid and short-term funds, with a time horizon of six months to a year, have moved to arbitrage funds, owing to superior post-tax returns," said Dhaval Kapadia, director, investment advisory, Morningstar India.
| What are abitrage funds? |
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An arbitrage fund is a type of mutual fund that tries to take advantage of the price difference (of the same asset) between two or more markets or market segments. Arbitrage funds work well in volatile markets, as fund managers are able to capitalise on differences in prices of a stock between the equity market and the futures market. Arbitrage fund managers reduce the risk in equities by hedging them, using derivatives. Arbitrage is the simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. Arbitrage exists as a result of market inefficiencies; it provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time. |
The Budget had increased the tenure for claiming long-term capital gains for debt funds from 12 to 36 months. While long-term capital gains were earlier taxed at 10 per cent without indexation, or 20 per cent with indexation, whichever was lower, the new guidelines did away with the 10 per cent option.
For one year, liquid and ultra short-term funds have given returns of 8.4 and 8.8 per cent, respectively. This translates to post-tax returns of 5.8 to 6.2 per cent. Arbitrage funds have given returns of eight per cent. No tax to be paid if units of these funds are redeemed after a year.
"With so much money coming in, returns from arbitrage funds have fallen to six per cent from eight to nine per cent a few months ago. The category still has a slight advantage over liquid and short-term debt funds, but the spread has narrowed considerably," said Nagpal.
Arbitrage funds came into the limelight after JM Financial's scheme collected in excess of Rs 5,000 crore in July 2014.
The scheme reportedly attracted funds, dangling the tax carrot provided by what is known in industry parlance as bonus stripping.
Bonus stripping refers to the practice of buying units of with the purpose of participating in a bonus issue, booking losses on the original value invested and then setting it off against gains from other sources.
However, industry observers believe the practice of bonus stripping has now stopped after Association of Mutual Funds in India issued a best-practice circular in May asking fund houses to stop accepting fresh subscriptions for bonus plans.
