Arbitrage schemes of mutual funds have fetched better returns than equity and debt schemes in the past one year, thanks to smaller asset sizes and algorithmic trading. These funds have given post-tax returns of 9% over the year, compared with 8.4% for debt funds. Value of equity funds fell 4.1%, as per a Crisil study.
Arbitrage funds take advantage of the price difference between cash and futures markets to generate returns. "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 and sharper returns," said the chief investment officer of a bank-promoted fund house on condition of anonymity.
"All said, 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," the above-quoted CIO said.
The ability of these funds to generate higher returns depends on the volatility in equity markets - the higher the better. Over the past one year, equity markets have been volatile, thereby creating opportunities for such funds with lower assets under management to generate superior returns.
"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 2006-2008 period, arbitrage funds gave healthy post-tax returns of 8-9%," said Jiju Vidyadharan, director - funds and fixed income research, Crisil.
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, the Crisil study said
According to Crisil Research, arbitrage funds can act as an alternative to short-term debt funds as they have generated higher returns in the short-term. During the past three and six months, arbitrage funds gave post-tax returns of 2.38% and 4.28%, respectively, vis-a-vis 1.84% and 3.5% for debt short-term funds and 1.99% and 3.74% for ultra short-term funds.
"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 dividend distribution tax," Vidyadharan said.
There are 15 funds in India that use arbitrage strategies to generate returns.
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