Investors flock to arbitrage funds...

...as dividend tax, curb on investment beyond 91-day maturity hit liquid funds.

With returns from liquid funds diminishing, arbitrage funds are witnessing increasing interest from high networth individuals (HNIs) as well as retail investors to park their money.

Since arbitrage funds have a tax advantage over liquid funds, returns from the former have become more attractive for investors. Arbitrage funds are taxed like equity funds at 15 per cent for short-term capital gains. However, 28 per cent is deducted from liquid funds as dividend distribution tax (DDT), which makes returns from these funds go down further.

Also, a recent directive from the Securities and Exchange Board of India (Sebi) has prevented liquid funds from investing in papers exceeding maturity of 91 days. This has further affected returns of these funds. Rates on papers with 15-90 day maturities are expected to remain softer over the next couple of months due to enough money supply in the system.

To add to their benefit, arbitrage funds take advantage of opportunities between cash and futures markets. These funds can buy a stock from the cash market and sell it in the futures market in order to gain from the price difference. This strategy normally acts as a shield against market volatility as both buying and selling transactions offset each other. Currently, one-month returns from liquid funds stand at 0.36 per cent. However, post-tax, the same goes down to around 0.07 per cent. In contrast, arbitrage funds are delivering returns of 0.35 per cent on a one-month basis. The post-tax, one-year returns from liquid and arbitrage funds stand at 5.5 per cent and 6.85 per cent, respectively.

“There are enough arbitrage opportunities available in the market due to intra-day upswings and downswings. The premium on futures to cash keeps expanding and contracting in a volatile market. The outlook is quite good for these funds in the coming months as markets are expected to remain volatile and even bullish,” said a fund manager.

It’s not just about returns. Experts say that arbitrage funds have been receiving good inflows for a couple of months now. For instance, Kotak arbitrage fund’s assets have moved up sharply by 280 per cent in the last two months. SBI arbitrage fund’s assets have also surged by 23 per cent during the same period, followed by JM’s 20.90 per cent.

Arun Agarwal, fund manager-arbitrage fund, SBI Mutual Fund, said: “As the cash market is moving up, there is a huge arbitrage opportunity. HNIs are moving some of their money from liquid funds to arbitrage funds as they don’t need money on a daily basis and can park the same for a longer period.”