Use arbitrage funds to park short-term money

But these only provide a hedge against volatility and are not beneficial for wealth building

If you are wary of the pace at which the equity market is galloping and want to park some funds for the short term, you could consider putting your money in arbitrage funds. These not only give better returns than typical short-term investments such as liquid and short-term funds, but also provide your portfolio a hedge against volatility in equity markets.

These are, however, not a good option for those looking to build wealth in the long term. Last month, two fund houses — Edelweiss and L&T — launched arbitrage funds. Some existing arbitrage funds have seen good inflows in the past six months.

Arbitrage funds invest in assets in at least two markets and make money when there is a difference in prices. For instance, there could be a difference between a stock’s price on the BSE and the National Stock Exchange, or between the price of an asset in the spot (cash) market and the futures (derivatives) market, or between this month’s futures contract and the next month’s.

According to data provided by Value Research, ICICI Prudential Equity Arbitrage Fund has seen its assets under management (AUM) rise from Rs 238 crore in December 2013 to Rs 558 crore in June this year. In the same period, IDFC Arbitrage Fund’s AUM rose from Rs 664 crore to Rs 1,333 crore and Kotak Equity Arbitrage Fund’s increased from Rs 484 crore to Rs 1,091 crore.

Vikas Sachdeva, chief executive of Edelweiss Asset Management, says arbitrage opportunities exist in all market conditions, helping investors generate relatively lower risk returns, whichever way the index moves.

However, Vidya Bala, head of mutual fund research at FundsIndia.com, says these funds don’t help much in a unidirectional market, headed upwards. But in case of a unidirectional fall, these funds provide a cushion. “The equity exposure in arbitrage funds is hedged against exposure to derivatives. These work in volatile markets when arbitrage opportunities are high,” she says.

Unlike equity funds, arbitrage funds don’t take open positions in cash markets, which makes these safer, says Hemant Rustagi, chief executive, Wiseinvest Advisors. But due to their equity exposure, arbitrage funds are taxed as equity funds and, therefore, give better returns than debt funds, provided you stay invested for a year. As a category, arbitrage funds have given returns of 9.14 per cent through a year, while liquid funds have given 9.11 per cent and short-term debt funds 8.35 per cent. “If you are looking to invest for a period of three months to a year, arbitrage funds are a good option,” Rustagi says.

The returns recorded by fixed maturity plans (FMPs), another popular option for short-term funds, are similar to those from arbitrage funds, but the liquidity is different It could be difficult to exit FMPs before maturity, though these are listed on exchanges. But one can redeem arbitrage funds any time after the lock-in period, usually three months, says Rustagi.

 

Since the role of arbitrage funds is to provide a hedge, they should not form more than 10% of your portfolio, Bala says. "If you are looking at building wealth over the long term, it is better to look at diversified equity funds," she adds.