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After the taxation of fixed maturity plans (FMPs) was changed by Finance Minister Arun Jaitley in his maiden Budget last year, fund houses have seen investors exit FMPs in a big way. Part of these investments has been directed to arbitrage funds that don’t attract long-term capital gains and provide returns similar to that of a debt scheme.
Post July, the corpuses of arbitrage funds have seen a consistent rise. Edelweiss Arbitrage Fund, for example, had a corpus of Rs 148.90 crore in August last year. In April this year, it stands at Rs 539.14 crore, according to data from Value Research. In the same period, Kotak Equity Arbitrage Fund has seen its corpus grow from Rs 1,905.64 crore to Rs 3,355.36. And DWS Arbitrage Fund’s corpus currently stands at Rs 291.45 crore compared to Rs 75.41 crore nine months ago.
Prior to the Budget announcement, FMPs worked out to be more tax-efficient if held for over 13 months, as investors could use the indexation benefit. Now, the gains are taxed at 20 per cent for investments over if held for over three years. Else, the returns are clubbed with the income and taxed as per the applicable income tax slab rate.
But does it make sense for investors to shift their FMP allocation to arbitrage fund? Experts say it depends on the investment horizon. Vetri Subramaniam, chief investment officer at Religare Invesco Asset Management Company, says as arbitrage funds are classified as equity investments, there are no long term capital gains tax, if a person remains with the fund for over a year. While FMPs have a lock-in period, investors in arbitrage schemes can exit at will paying the exit load, if they withdraw before a year.
Explaining the investment strategy, Harsha Upadhyaya, chief investment officer - equities at Kotak Mahindra Asset Management, says arbitrage funds take advantage of stock price difference in cash and derivative segments. For example, if a stock is trading at Rs 100 in the cash market and at Rs 101 in the futures, the fund managers take advantage of this discrepancy. “While these schemes invest in equities they don’t carry the risk of stock market fluctuations, as their returns are not altered by the market movement.”
They are best-suited for conservative investors looking at moderate returns from market in a tax efficient way. Historically, these funds have had returns between eight and 10 per cent. In the past one year, the category average of arbitrage funds is 8.77 per cent. The best performing fun returned 9.61 per cent and the worst performing gave 7.92 per cent. In the same period, FMPs’ annualised returns are between 7.61 per cent and 12.11 per cent.
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The three-year category average of arbitrage schemes stands at 8.77 per cent and five-year at 8.44 per cent. In the five year period, the best performing fund returned 8.97 per cent and the worst performing gave 7.82 per cent returns.
If you are looking for an investment horizon between one and two years, arbitrage funds work out to be a better option than a debt fund due to tax efficiency. For a shorter term, investors should look at debt funds. Arbitrage funds don’t give consistent returns month-on-month like, say, a liquid fund. Their returns vary every month, depending on the opportunities available in the derivates segment.
Subramaniam of Religare point out that before investing, investors should ensure that the scheme is a pure arbitrage fund. Over time, fund houses have introduced variations of these funds. Today, there are arbitrage funds that also invest part of their corpus in stocks (called as directional trade) and the remaining is used for arbitrage opportunities. “While such a strategy can give higher returns, it also carries the risk of lowering them if the markets don’t do well.”
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