Make more money from these funds

Small investors usually keep money in an emergency fund or for amounts which may be needed in a short period, they keep it in savings account of banks. Investors who know mutual funds well, invest short duration funds in overnight or liquid fund schemes. In these options, investors get good interest from savings accounts. The risk is also limited.

But did you know that there is another low-risk option available in the market for short term? It’s arbitrage funds. An additional advantage of this fund is that it is more tax efficient than debt funds like overnight or liquid funds.

What are arbitrage funds?
Arbitrage funds are mutual funds that can invest in other instruments like stocks, bonds, money market instruments. But they make profit by taking advantage of the difference in the price of the same underlying asset in different segments of the capital market.

How do they work
Under this, the underlying security like shares or bonds is bought or sold simultaneously in different markets so that profit can be made without any risk. Suppose the price of a security is different in two different markets. So you buy that security where it is cheaper and sell it where it is expensive. This way you make profit.

Buying and selling transactions are done simultaneously so that there is no risk of price changes. For example, suppose a fund manager buys a share in the cash market for Rs 100 and its price in the futures market is Rs 102, then he can earn a profit of Rs 2 by selling the same share in the futures market.

What are the risks
According to rules, arbitrage funds have to invest 35 percent of their assets in debt or money market instruments, that is, the credit risk in such investment instruments is high. Therefore, before investing in arbitrage funds, you need to check the credit quality of the debt portion of that fund. The returns of arbitrage funds also depend on the market conditions.

But due to the advantages of arbitrage, these mutual fund schemes are less risky and taxed like equity.

Should you invest?
Arbitrage funds are ideal for investors who want to earn high returns on their short term investments with very low risk. These funds are more attractive to investors in the higher tax bracket, as they get the benefit of tax savings. Basically, the tax on investment in this fund is same as that of Equity Mutual Funds. If the investment is less than one year then short term capital gains tax of 15 percent and if the investment is more than one year then long term capital gains tax of 10 percent is levied. Not only this, investment up to Rs 1 lakh is also free from long term capital gains tax.

So the returns after deducting tax in this fund are higher as compared to money market or liquid funds.
Investors get better tax savings by investing in this fund even in short term.

Returns on arbitrage funds
What kind of returns have arbitrage mutual funds given. On an average, arbitrage mutual fund has given a return of 4% every three years and 5% every five years. Even in one year, their returns have been between 3 to 4%.
Lowai Navlakhi, board member of Association of Registered Investment Advisors (ARIA), says arbitrage funds benefit from price differences due to volatility in the equity market. The best approach is to redeem this fund just before any monthly futures expire i.e. exit. But keep in mind that if the investment is less than three months, then liquid or money market funds can still prove to be better than arbitrage funds.

So overall it can be said that arbitrage funds are not suitable for such investors who want to invest for a very short period of time. If you invest in this type of fund for at least three months, then you can earn profit. If you have made up your mind to invest in this type of fund, then that’s great, but before taking the final decision, do take the opinion of your investment advisor once.

(Disclaimer: Stock/mutual fund recommendations by experts or brokerages are their own and not those of the website or its management. Money9.com advises readers to check with certified experts before taking any investment decisions.)