Arbitrage funds back in favour as market volatility boosts returns

Interest in low-risk equity products of mutual fund schemes see interest after extended period of outflows

Arbitrage funds have recorded net inflows for three months straight, after steep outflows for half a year before that. The trend changed as mutual fund (MF) schemes improved amid a rise in equity market volatility.

Investors redeemed over Rs 31,000 crore from arbitrage schemes between June and November before putting in Rs 3,000 crore in the last three months, shows data from the Association of Mutual Funds in India (Amfi).

Arbitrage funds are low-risk equity products with returns often comparable to liquid funds in the debt MF space. These schemes run fully-hedged equity positions and generate returns from the differential in the prices of stock futures and the underlying stock.

The performance of arbitrage schemes is dependent on the price spread of equities in the cash market and the futures market. These spreads have improved in the recent months leading to better returns, according to fund managers.

Data from Value Research shows that most arbitrage schemes have shown significant improvement in performances recently. For example, the average monthly returns of hybrid schemes was 0.6 per cent in the last three months compared to around 0.4 per cent in the previous six months.

Arbitrage fund managers have gained from a higher volatility in the equity market in the recent months.

"Arbitrage funds tend to do well during periods of heightened volatility. It is because arbitrage opportunities go up during such phases in the market," said Viral Bhatt, founder of Money Mantra.

Arbitrage fund returns are in line with the money market rates. "They tend to track money market rates. And with interest rates moving up, arbitrage funds have also started to do better," said Dhaval Kapadia, director, portfolio specialist, Morningstar Investment Adviser India.

The returns are slightly higher to that of liquid funds, giving arbitrage schemes a dual advantage over its debt counterpart. Arbitrage funds enjoy an upper hand over their debt counterpart on the taxation front, since they are taxed as equity funds.

"Arbitrage funds have the tax advantage over debt schemes. For example, if the investment period is more than one year and less than three years, equity fund returns are taxed at 10 per cent, while debt fund returns are taxed at the investor's slab rate. Furthermore, long-term capital gains under Rs 1 lakh do not attract tax," said Rushabh Desai, founder of Rupee With Rushabh Investment Services.