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astha swamy
by on May 30, 2022
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Mutual fund schemes come in various shapes and sizes. While some MF schemes invest in equity, others invest in debt. Generally, equity funds are riskier than debt funds. However, arbitrage funds are perhaps the only type of equity-focused mutual funds that provide debt-like stability. Read on to know the meaning of arbitrage mutual funds, typical returns, the importance of the fund manager and ways to find the best arbitrage funds.   

The Meaning of Arbitrage Mutual Funds

Let's understand the meaning of arbitrage mutual funds with an example. Imagine finding a stock whose spot price is INR 100 and the lot size is 500 shares. Now, you find that the futures price of the same stock is at INR 105. So, you buy the stock in the spot market and sell it at the futures price of INR 105. Here, the difference between the futures price and the spot price (also known as the Spread) of the stock you buy and sell is known as arbitrage. 

The best arbitrage mutual fund managers constantly scan the market to spot such opportunities and place bets. Arbitrage mutual funds usually invest in cash and futures markets. But, the fund managers of such funds may also look beyond traditional equity stocks and trade currencies or commodities. They may also execute numerous trades every year to make considerable profits.

Earlier, arbitrage mutual funds were allowed to trade in the same exchange. However, according to SEBI's latest guidelines, interoperability has been allowed. So, fund managers may buy shares at one exchange and sell them at another. Hence, if a stock's price is INR 50 at BSE (Bombay Stock Exchange) and INR 52 at NSE (National Stock Exchange), arbitrage funds may buy and sell such shares to pocket the difference.

Arbitrage funds are immensely popular among investors. It allows them to invest in the equity market without being exposed to its risks. 

The Importance of Choosing the Best Arbitrage Fund Manager

An arbitrage fund is as good as its manager. The quality and reputation of the manager separate the best arbitrage funds from the rest.

Generally, arbitrage fund managers enter the market with a medium to long term horizon. This minimizes the volatility created due to equity exposure. And, when the fund manager does not invest in equity, they park the money in fixed income instruments. The instruments chosen by arbitrage fund managers are usually the best debt securities with a high credit rating. Alternatively, they may invest the money in term deposits, debentures and zero-coupon bonds.

Hence, while investing in an arbitrage mutual fund, you must check the fund manager's credentials and track record. 

Who is Eligible for Arbitrage Fund Investments?

Arbitrage funds generate revenue by buying and selling stocks. However, what makes them unique is that these funds carry fewer risks than conventional equity funds. As a fact, the risk level of arbitrage mutual funds is equivalent to debt funds. Most arbitrage mutual funds consider the Crisil BSE 0.23% Liquid Fund as the benchmark. 

So, any investor looking to earn decent returns without the risks associated with equity mutual funds may invest in arbitrage funds. Also, if you want a safe place to park your money when the market is extremely volatile, arbitrage funds might be your best choice. However, as the risks associated with arbitrage funds are low, the returns might also be lower than pure equity funds. 

Things to Consider While Investing in Arbitrage Mutual Funds

  • Risk

Arbitrage funds are good until many investors turn to them. When too many investors hunt for arbitrage opportunities, the Spread erodes, leaving fund managers with no option but to invest in debt funds.

  • Returns

Since most arbitrage funds consider the Crisil BSE 0.23% Liquid Fund as the benchmark, the returns are almost similar to liquid funds. Typically, arbitrage fund returns range between 7% and 9% per annum. 

  • Expense

Mutual fund houses levy an expense fee on arbitrage mutual funds. Also, you may have to pay an exit load if you withdraw the investment before a specific period. Hence, the actual returns might be considerably lower than what you expect. 

The EndNote

Arbitrage mutual funds provide many benefits for investors. It is the best option for people looking to earn higher returns than term deposits at low risk. PGIM Mutual Fund offers the best arbitrage mutual funds with a consistent performance track record. Check the factsheet before investing and reap rich dividends. 

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