In an endeavour to achieve higher returns on their investments with\nless risk involved, investors are constantly in search of different investment\noptions. Initially, investors (especially the risk-averse ones) put their money\non debt instruments until the mayhem of corporations defaulting to repay fiasco\nhappened. <\/p>\n\n\n\n
Already the finance industry is experiencing a lot of volatility due to\nmacro and microeconomic factors. Equity markets are the foremost to undergo extreme\nhighs and lows. And investing in pure equity is not suitable for the fainthearted.\n<\/p>\n\n\n\n
In this scenario, even aggressive investors are being extra cautious. <\/p>\n\n\n\n
And the current volatile environment opens a tiny door of opportunity to\nexploit the price differences between two markets to generate returns.<\/p>\n\n\n\n
In finance, investment opportunities created by the mispricing of an\nasset in two different markets are called arbitrage opportunities. When you are\nsimultaneously buying and selling the same product in different markets and\nlocking the price differential, it becomes your clear gain, after adjusting the\ncosts. <\/p>\n\n\n\n
The mutual fund industry has a separate product category to tap such \u201cmispricing\u201d opportunities\u2014arbitrage funds.\n<\/strong><\/p>\n\n\n\n What is An Arbitrage\nfund?<\/strong><\/p>\n\n\n\n An arbitrage fund is a sub-category of Hybrid fund<\/a> 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. <\/p>\n\n\n\n As per recategorization norms, an arbitrage fund will follow the arbitrage\nstrategy and invest at least 65% of its total assets in equity & equity\nrelated instruments as per the mandate under normal and defensive conditions.\nIt will also allocate the remaining assets to debt and money market\ninstruments. <\/p>\n\n\n\n Why is an Arbitrage Fund,\ncatching up?<\/strong><\/p>\n\n\n\n Typically, an arbitrage fund is less risky than the pure equity fund<\/a> 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. <\/p>\n\n\n\n Currently, Arbitrage funds are gaining momentum because of the new\nvaluation norms imposed. When the great\ndebacle in the debt market surfaced, several fund houses that had taken the\ninvestors for a joy ride were exposed.<\/p>\n\n\n\n Due to these instances, the regulator introduced a slew of new regulations<\/a> that was intended to make debt mutual funds<\/a> a lot safer place for investors. Some of those were\u2026<\/p>\n\n\n\n After the implementation of these prime regulatory norms, the fund\nhouses reduced the holding duration of the liquid funds, but in turn, the\nreturns have been moderate and that impacted the performance of the funds. <\/p>\n\n\n\n Per se, considering the taxation norms, Arbitrage funds are categorised\nas equity-oriented schemes. So, any arbitrage fund held for up to 1 year is\nliable for a Short-term capital gain (STCG) that is taxed at the rate of 15 %. <\/p>\n\n\n\n And fund held for more than 1 year will be treated as Long term capital\ngain (LTCG), to be taxed at the rate of 10% for gains in excess of Rs 1 lakh in\na financial year.<\/p>\n\n\n\n On the other hand, Short-Term Capital Gains (STCG) earned via short-term debt funds for a holding period less than 36 months, are taxed at the applicable rate as per your tax slab. And the Long-Term Capital Gains<\/a>, i.e. gains made after staying invested for more than three years in case of debt mutual funds are taxed at 20% after opting for the indexation benefit. <\/p>\n\n\n\n Additionally, if one opted for the dividend option, the dividend\ndeclared by liquid funds carries effectively 28.84% Dividend Distribution Tax\n(including surcharge and cess). <\/p>\n\n\n\n In brief, the pros of arbitrage funds outweigh that of Debt funds\n(liquid funds):<\/p>\n\n\n\n Hence from the past few months, the Asset Under Management (AUM) of\nArbitrage funds has witnessed growth, as seen from the table below. <\/p>\n\n\n\n Table\n1: AUM Growth<\/em><\/strong><\/p>\n\n\n\n