Arbitrage Mutual Funds
If you remember, while discussing hybrid mutual funds in chapter 20 of this module, we have briefly discussed what Arbitrage funds are? But how is it different from other mutual funds, and who is it for? We will answer all of these in this chapter. So, without further ado, let's start:
As you might know, different financial instruments are traded in different markets. Sometimes, the same financial instrument is also traded in different markets, at different prices at times. Arbitrage takes advantage of this price difference between two markets by buying low at one market and selling high at another market & vice versa, thus making a profit in the whole process.
For example, if ITC Ltd is trading at ₹236.55 in BSE and ₹236.50 in NSE, an investor will purchase ITC at NSE and sell at BSE and make a profit of ₹0.05 per share in the process.
However, this is not easy. You need to be on top of what is happening in various markets and have extensive knowledge of how the markets work.
Honestly speaking, most of us do not possess the skills to arbitrage. And this is where Arbitrage Mutual Funds come into play. The fund manager arbitrages on our behalf – thus helping us earn a profit (or loss).
What are Arbitrage Mutual Funds?
Arbitrage funds are a kind of equity-oriented hybrid funds which take the benefit of arbitrage opportunities in the market. A fund manager buys and sells shares in different markets and profits from the exercise.
So, what is the difference between arbitrage funds and any other equity fund?
In an equity fund, the fund manager purchases a share when he/she sees potential and holds on to it and sells at a higher price to earn profits. In an arbitrage fund, a purchase is made if only the fund manager sees an opportunity to profit by selling it in another market. If there are no arbitrage opportunities, the fund manager will invest in money market instruments and other short-term debt funds and wait.
As we illustrated in the example above, the profit earned per arbitrage trade can be quite small. Hence, a fund manager will make several trades during the day to generate reasonable profits.
The fund manager and his/her team play a substantial role in the arbitrage fund.
Who is it Ideal For?
Arbitrage funds have a low-risk profile, often comparable to debt funds. When there are no arbitrage opportunities in the market, arbitrage funds keep their money in the debt market. Many arbitrage funds follow the Crisil BSE 0.23% Liquid Fund Index as a benchmark.
Hence, arbitrage funds are ideal for people who want to enjoy some exposure in equity, but their risk appetite is low. In a volatile market, arbitrage funds are an ideal choice to park your funds and bide the tide out.
Examples of Arbitrage Funds:
Let us take a look at a few arbitrage funds available in India and their short term and long-term returns:
Data were taken on 5.10.2021