What are Arbitrage funds and Its Returns ?

Arbitrage funds take advantage of the price difference between cash and futures markets to generate returns.
Arbitrage funds have a low risk - return trade - off and generate moderate returns.

Arbitrage funds are a niche category, which tries to take advantage of the price difference between cash &  futures (Derivatives) markets to generate returns. The ability of these funds to generate higher returns depends on the volatility in equity markets - the higher the better.

Experts believe that risk averse investors who shy away from equities owing to high volatility can look at arbitrage funds as a relatively safer option within equities.

Arbitrage funds have been the best performers in the past 12 months, clocking the highest post - tax returns. With the increased volatility in the Indian equity markets in the past one year, these Arbitrage funds have been able to benefit on the arbitrage advantage between the cash and derivatives segments.
An analysis by CRISIL shows that between July 2011 & June 2012, Arbitrage funds gave post tax returns of  9% against 8.4% for debt funds and minus 4.1% for equity funds. The analysis is based on the performance of 8 arbitrage funds.

Over the last one year, the Indian equity markets have been volatile, thereby creating opportunities for such funds to generate high returns. As arbitrage funds predominantly invest in equities, they are treated on a par with other equity funds for tax treatment.


Post Tax Returns of 8-9%..!

Mr. Jiju Vidyadharan, Director - Funds and fixed income research -  CRISIL said, “Arbitrage funds have a low risk-return trade-off and generate moderate returns. Arbitrage opportunities to be exploited depend upon the extent of volatility in the equity market - the higher the volatility, the higher the returns. During the volatile 2006 to 2008 period, arbitrage funds gave healthy post tax returns of 8-9%. The dividend option of arbitrage funds is further lucrative as dividends are tax free for equity funds, while short maturity debt funds are subject to a dividend distribution tax.The category has also provided higher returns in the short term and can act as an alternative to short-term debt funds.

During the last 3 and 6 months, arbitrage funds gave post tax returns of 2.38% & 4.28%, respectively compared to 1.84% & 3.5% for debt - short funds & 1.99% and 3.74% for ultra short-term funds.
Arbitrage market does not have many players these days; this factor opens up a lot of scalping opportunities. Also, machine trading is helping funds to scalp higher & sharper returns. Arbitrage fund as a category has shrunk in size. Net investment in this category is minuscule. It is not very difficult to outperform, managing small sums of money.

As arbitrage funds predominantly invest in equities, they are treated on a par with other equity funds for tax treatment. Risk-averse investors, who shy away from equities owing to high volatility, can look at arbitrage funds as a relatively safer option within equities.

There are 15 funds in India that use arbitrage strategies to generate returns. However, it is important that investors carry out basic due diligence before selecting a fund.
Investors need to differentiate between pure arbitrage and arbitrage plus funds. In the former, the equity component is completely hedged, while the latter can take unhedged positions and thus carry a higher risk. Only 8out of the 15 arbitrage funds can be considered as pure arbitrage funds as on July 18, 2012.

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