Best Arbitrage Funds : Top Performing Arbitrage Funds to Invest in 2022

Best Arbitrage funds are a type of mutual fund that uses the price differential between the cash and derivatives markets to produce returns. It follows a strategy of simultaneously buying and selling securities in the cash and futures markets. The return you get depends on the volatility of the assets. We have covered the following in this article on the best arbitrage funds.

Introduction to Best Arbitrage Funds

The word ‘arbitrage’ means the same security is bought and sold in different markets to profit from the price difference. It exploits inefficiencies in the markets to generate profit for the investors. It helps you profit from the market without taking too much risk in your investment. Arbitrage funds invest most of the corpus in equity and equity-related securities. However, they also invest in short-term debt securities and money market instruments. You may consider investing in arbitrage funds with a time horizon of one to three years

Top 10 Best Performing Arbitrage Funds

The table below shows the top-performing arbitrage funds based on the past 3-year and 5-year returns:

Who Should Invest in Arbitrage Funds?

You may consider putting your money in arbitrage funds if you are comfortable with stock investments. It is a low-risk investment as compared to many equity funds. Arbitrage funds offer attractive returns at lower-risk as compared to other equity investments. You could consider investing in arbitrage funds if you fall in the higher tax bracket.

It offers the twin benefits of lower risk with tax-efficient returns if you fall in the highest income tax slab. You may consider diversifying your portfolio with arbitrage funds. It is suitable for investors looking at equity investments, but not extremely aggressive investors. You may invest in arbitrage funds to meet short-term or medium-term financial goals. It is an investment suitable for first-timers in the stock market. You could get an attractive return in a volatile market.

Taxability of Arbitrage Funds

Arbitrage funds are considered as equity funds for tax purposes. It is because they invest at least 65% of the total assets in equity and equity-related instruments. If you sell arbitrage funds within one year, your gains are treated as short-term capital gains. You would have to pay short-term capital gains tax at 15% with applicable cess. If arbitrage funds are sold after one year, you will incur long-term capital gains tax at 10%.

It is only on the capital gains above Rs 1 lakh in a financial year. Arbitrage funds, either the growth or dividend option, are taxed as equity funds. However, dividends from arbitrage funds are taxable in the hands of investors depending on the income tax bracket. For example, if you are in the 30% income tax bracket, you would have to pay tax at that rate on your dividends.

Risks Associated With Arbitrage Funds

Arbitrage funds invest most of the corpus in equity and equity-related instruments. However, they also invest in debt instruments when there are insufficient arbitrage opportunities. Your investment in arbitrage funds is affected by interest rate risk. It means you could suffer losses due to the change in interest rates.

However, you must also factor in credit risk, which is the risk of default on both principal and interest payments by the borrower. Arbitrage funds may face other risks. Arbitrage opportunities come in phases. You would find arbitrage opportunities in a volatile market. You also have arbitrage opportunities when stock markets peak. However, there are very few opportunities for arbitrage funds to make a profit during a stock market correction.

Arbitrage funds are risky in the short-run. You could incur an exit load if you redeem the investment within one month. You may consider investing in arbitrage funds with an investment horizon of at least one year. You could ignore arbitrage funds if you are a long-term investor. The arbitrage strategy could contain the downside risk. However, it may also limit the possibility of profit from the investment. An aggressive investor may consider putting money in other equity funds as compared to arbitrage funds.

Things to consider before investing in an arbitrage fund

You must consider the following points before investing in an arbitrage fund.

1. Risk profile: Arbitrage funds put your money in equity and equity-related instruments. You may consider avoiding arbitrage funds if you are an extremely conservative investor. It is because arbitrage funds perform poorly during a stock market correction. Aggressive investors could avoid arbitrage funds as they offer a lower return as compared to many equity funds over the long-run.
2. Investment horizon: You may consider investing your money in arbitrage funds with a time horizon of six months to three years. You may consider short-term debt funds instead of arbitrage funds for a time horizon of three to six months. However, you may avoid arbitrage funds if you are a long-term investor with an investment horizon of over five years.
3. Size of the fund: You may consider selecting a large-sized arbitrage fund that is less vulnerable to sudden redemption by major investors. Keep a close eye on the debt portion of your arbitrage fund and access its credit quality.
4. Expense Ratio: Arbitrage funds have a high turnover ratio because of frequent trading by the fund manager. You may find the expense ratio to be higher as compared to other equity funds.

Advantages of investing in arbitrage funds

The following are some of the major advantages of investing in arbitrage funds.

• Tax benefits: Arbitrage funds invest at least 65% of the total corpus in equity and equity-related instruments. It is taxed as an equity fund even though it has a debt component. Short-term capital gains on holding the arbitrage fund for under one year are taxed at 15%. You would have to pay long-term capital gains tax at 10% on capital gains if you hold the investment for one year or more. However, long-term capital gains below Rs 1 lakh in a financial year are tax-free. Arbitrage funds are more tax-efficient as compared to debt funds in the short term. You may consider arbitrage funds if you fall in the higher tax brackets.
• Risk levels: Arbitrage funds are less risky as compared to other equity funds. You could look at a decent return with lower risk.
• Good for volatile markets: Arbitrage funds earn profit and generate good returns in a volatile market.