Arbitrage funds are a type of mutual fund. They have a low risk compared to other funds.
What are arbitrage funds?
“In arbitrage funds, stocks are purchased at a particular price and sold at a higher price to mark the profit”. It gets benefits from stock prices and futures contracts price. It is a hybrid fund. Hybrid means a mixture of debt and equity. The ratio of debt to equity is 35:65. The cash market price of a stock is called the spot price. The price at which particular stock is available.
E.g. The cash price of a share of XYZ is 100rs. Then, you can purchase it at 100 rs. and own that much portion of a company when the trade is executed and if the market is bullish and sell price is 120 rs. then arbitrage profit is 20rs.
In case of expectation of low price, the market will be bearish. The difference between the price of purchase and future price will be an ”arbitrage loss”.
This is one way and another way is purchasing in one stock exchange and selling in the other. E.g. Price difference between Ahmedabad stock exchange and Delhi stock exchange.
Low risk: Arbitrage funds are less risky as they do invest partly in debt funds.
Income tax benefit: Arbitrage funds are treated as equity for calculating tax. It applies to holding. If you are holding an investment for less than a year, the short-term capital gain will be applicable. And if more than 1 year, the long-term capital gain will be applicable.
Suitable for the volatile market: It gives more benefits when the market is fluctuating as in that case, the prices of stock will change, which can earn higher profit.
Lower profit: Arbitrage funds can earn profits, but they are marginal. So, more transactions or trading has to be done for higher profit.
Unpredictability: The benefit is a limitation too and that is a volatile market. Fluctuations may book “arbitrage loss”.
High investment cost: High cost is associated with arbitrage funds. As the number of transactions is high, the transaction cost is applied. Along with it, exit load is applicable too.
Should you invest?
You should invest in arbitrage funds if you are a cautious market observer. If you can study the market well then, it might be a good option for you. But, before investing, factors that should be considered are financial goals, fund performance, costs, etc. You should read and understand the conditions before going for it.