During the COVID-19 lockdown, individuals are losing patience — moving freely and not following the necessary social distancing. This lack of civic sense and maturity on their part is weakening our fight against the deadly contagion pathogen.
The capital markets, as a result, also has witnessed intense volatility and bears are running lose. Certain sections of investors, however, have shown tremendous maturity during these challenging times. Even the debt markets aren’t safe either after the winding down of Franklin Templeton’s six debt schemes due to liquidity reasons.
In fact, it has made investors jittery. With both the prime asset classes being uncertain, is there a way out for the investors? Only way to unlock the potential of volatility would be through arbitrage opportunities by launching an arbitrage fund.
An arbitrage fund is a sub-category of Hybrid fund that seeks opportunities from differential pricing in two different segments (spot and futures or cash and derivatives) of the equity market. Such opportunities are usually tapped in volatile market conditions.
Typically, an arbitrage fund is less risky than the pure equity fund because participants are not speculating on market movements. Instead, they bet on the mispricing of a share/asset that has happened between two related markets. It is seen that the mispricing of security is far more frequent in high volatility months than in low volatility months.
Therefore some of the noteworthy fund houses including Mirae Asset Mutual Fund launched Mirae Asset Arbitrage Fund (MAAF). It is an open-ended arbitrage scheme investing in arbitrage opportunities. The scheme will follow arbitrage strategy and invest at least 65% of its total assets in equity & equity related instruments as per the mandate under normal and defensive conditions and will hedge its assets.
Hence in terms of risk-return potential, MAAF is moderately low and suitable for investors who have a moderately low risk-appetite and are seeking income through investment in fully hedged equity investments (arbitrage opportunities) and fixed income instruments.
Table 1: Details of Mirae Asset Arbitrage Fund (MAAF)
| Type | An open ended scheme investing in arbitrage opportunities | Category | Arbitrage fund |
| Investment Objective | To generate capital appreciation and income by predominantly investing in arbitrage opportunities in the cash and derivative segments of the equity markets and the arbitrage opportunities available within the derivative segment and by investing the balance in debt and money market instruments. There is no assurance or guarantee that the investment objective of the scheme will be realized. |
||
| Min. Investment | Rs 100 and in multiples of Re 1 thereafter | Face Value | Rs 10 per unit |
| Plans |
|
Options |
*Default option |
| Entry Load | Nil | Exit Load |
|
| Fund Manager | Mr. Jignesh Rao (Equity portion), Mr. Jigar Shethia (Equity portion), and Mr. Mahendra Kumar Jajoo (Debt portion) | Benchmark Index | NIFTY 50 Arbitrage Index |
| Issue Opens | 03/06/2020 | Issue Closes: | 12/06/2020 |
(Source: Scheme Information Document)
How will the scheme allocate its assets?
Under normal circumstances, the asset allocation pattern shall be as under:
Table 2a: Asset Allocation under normal circumstances
| Instruments | Indicative allocations (% of Total Assets) | Risk Profile | |
| Minimum | Maximum | ||
| Equities and Equity Linked instruments* | 65% | 90% | Medium to High |
| Derivatives including Index Futures, Stock Futures, Index Options and Stock Options | 65% | 90% | Medium to High |
| Debt securities, money market Instruments & cash and cash equivalents | 10% | 25% | Low to Medium |
| Units issued by REITs & InvITs | 0% | 10% | Medium to High |
*Equity allocation is measured as the Gross exposure to equities, equity related instruments and derivatives. The Equity allocation so built, at any point in time, would be completely hedged out, using derivative instruments that provides an equal but opposite exposure, thereby making the Net exposure market-neutral.
(Source: Scheme Information Document)
Under defensive circumstances, the asset allocation will be as follows:
Table 2b: Asset Allocation under defensive circumstances
| Instruments | Indicative allocations (% of Total Assets) | Risk Profile | |
| Minimum | Maximum | ||
| Equities and Equity Linked instruments* | 0% | 35% | Medium to High |
| Derivatives including Index Futures, Stock Futures, Index Options and Stock Options | 0% | 35% | Medium to High |
| Debt securities and Money Market Instruments (including the margin money deployed in derivative transactions) | 65% | 100% | Low to Medium |
| Units issued by REITs & InvITs | 0% | 10% | Medium to High |
*Equity allocation is measured as the Gross exposure to equities, equity related instruments and derivatives. The Equity allocation so built, at any point in time, would be completely hedged out, using derivative instruments that provides an equal but opposite exposure, thereby making the Net exposure market-neutral.
(Source: Scheme Information Document)
Defensive circumstances are when the arbitrage opportunities in the market are negligible, in view of the fund manager or returns are lower than alternative investment opportunities as per allocation pattern. The allocation under defensive considerations will be made keeping in view the interest of the unitholders.
- Investment in derivatives can be made upto 90% of the net assets of the scheme.
- The Scheme may invest in securitised debt upto 50% of debt portion.
- The Scheme may invest in Structured Obligations / Credit Enhancements not exceeding 10% of the debt portfolio of the scheme and the group exposure in such instruments shall not exceed 5% of the debt portfolio of the scheme.
- The scheme may participate in repo in corporate debt securities.
- The Scheme may engage in securities lending in accordance with the guidelines issued by SEBI. A maximum of 20% of net assets will be deployed in securities lending and the maximum single counterparty exposure will be restricted to 5% of net assets outstanding at any point of time.
- If permitted by SEBI Regulations, the Scheme may engage in short selling of securities in accordance with the guidelines issued by SEBI.
What will the Investment Strategy be?
The scheme will seek to achieve its investment objective primarily by employing various strategies which seek to exploit available arbitrage opportunities in markets. If suitable arbitrage opportunities are not available in the opinion of the Fund Manager, the scheme may predominantly invest in debt and money market securities.
The market provides opportunities to the investor to derive returns from the implied cost of carry between the underlying cash market and the derivatives market. This provides for opportunities to generate returns that are possibly higher than short term interest rates with minimal active price risk on equities. Implied cost of carry and spreads across the spot, futures and options markets can potentially lead to profitable arbitrage opportunities.
The Scheme would carry out arbitrage strategies, which would entail taking offsetting positions in the various markets simultaneously. The arbitrage strategy can also be on account of buy-back of shares announced by a company and/or differences in prices between two exchanges/markets. In this case the arbitrage strategy will not include an offsetting derivatives transaction.
The Investment Manager will use a disciplined quantitative analysis while accessing arbitrage opportunities. The Investment Manager will have an effective risk monitoring and control process to ensure adherence to regulatory guidelines and limits.
Risk Control Measures
Investments made from the net assets of the Scheme would be in accordance with the investment objective of the Scheme and the provisions of the SEBI (MF) Regulations. The AMC will strive to achieve the investment objective by way of a judicious portfolio mix comprising of Debt and Money Market Instruments. Every investment opportunity in Debt and Money Market Instruments would be assessed with regard to credit risk, interest rate risk, liquidity risk, derivatives risk and concentration risk.
Who will manage Mirae Asset Arbitrage Fund?
The Mirae Asset Arbitrage Fund will be co-managed, the equity portion will be managed by Mr Jignesh Rao and Mr Jigar Shethia, whereas Mr Mahendra Kumar Jajoo will manage the debt portion of the scheme.
Mr Jignesh N Rao has more than 15 years of experience in the field of Equity dealing and has done BSC along with a Post Graduate Dimploma in Business Administration. Rao was associated with Motilal Oswal Asset Management Company Ltd. as Dealer – Equity.
Mr Jignesh Rao will manage the equity portion of the Scheme. Currently at the Mirae Asset Mutual Fund Mr Rao does not manage any other scheme.
Mr Jigar Bharat Shethia has more than 14 years of experience in the field of Equity dealing. Prior to this assignment, Mr. Shethia was associated with Sushil Financial Services Pvt Ltd as Assistant Manager – Equity.
Mr Jigar Shethia too will be handling the equity portion of the scheme. Currently he does not manage any other scheme of Mirae Asset Mutual Fund.
Mr Mahendra Jajoo will manage the debt portion of the Scheme. He holds over has over 27 years of experience in the field of financial services including 13 years of experience in Fixed Income fund management. Mr Jajoo is a Chartered Accountant (CA), Company Secretary (ACS) and Chartered Financial Analyst (CFA)
At Mirae Asset Mutual Fund, Mr Jajoo is responsible for supervising all the debt schemes of the fund house. Prior to joining the AMC, Mr Jajoo was a Director with AUM Capital Markets Ltd. He has also been associated with organizations like Pramerica Mutual Fund (now known as DHFL Pramerica Mutual Fund), Tata Mutual Fund, ABN AMRO Asset Management Ltd and ICICI Group.
Currently, at Mirae Asset Mutual Fund he co-manages/manages Mirae Asset Savings Fund, Mirae Asset Cash Management Fund, Mirae Asset Dynamic Bond Fund, Mirae Asset Hybrid Equity Fund (debt portion), Mirae Asset Fixed Maturity Plan – Series III – 1122 days, Mirae Asset Equity Savings Fund (debt portion), Mirae Asset Overnight Fund and Mirae Asset Short Term Fund.
Outlook for Mirae Asset Arbitrage Fund:
Arbitrage Funds aims to exploit the price differential in two different segments (spot and futures or cash and derivatives) of the equity market. They buy stocks in the spot market and sell in the future market simultaneously thereby making gains with the price differential (called the spread).
The differential usually is in sync with the prevailing interest rates in the economy; but depending on the market volatility, it could sometimes be higher as well. But tapping arbitrage opportunities is a challenging task, owing to the key risks associated with the arbitrage strategy:
* Lack of opportunity available in the market
* The risk of mispricing or improper valuation and the inability of derivatives to correlate perfectly with underlying assets, rates, and indices.
* Execution Risk: The prices which are seen on the screen need not be the same at which execution will take place. This is because arbitrage opportunities are often short-lived.
Another noteworthy point is that the SAF is also expected to have a high portfolio churn, especially in a volatile market. While there is an execution risk when implementing arbitrage strategies across various segments of the market, it may result in missed investment opportunities, or may also result in losses/high transaction costs.
Hence, the performance of the Mirae Asset Arbitrage Fund depends on the swift effective versatile construction of the portfolio using the arbitrage strategy.
Thus, as an investor, before you invest in any arbitrage fund, you ought to recognise that arbitrage opportunities might not always work out. Since there’s a 10% Long Term Capital Gains Tax (LTCG) on arbitrage funds for gains above Rs 1 lakh in a financial year, arbitrage funds have become unattractive for big-ticket investments.
[Read: How LTCG Tax On Equity Investments Can Derail Your Financial Plan]
So, before investing consider your investment objective, time horizon, and risk appetite.
This article first appeared on PersonalFN here
