Arbitrage funds, which buy in the cash markets and sell in the futures at higher prices, have been feeling the impact of the ongoing volatility, with futures trading at a discount to spot market prices. This led to spreads for such funds shrinking, with some fund houses suspending fresh flows into these schemes. This is to insulate new investors from the dislocation in the market.
Both Tata MF and ICICI Prudential MF had suspended fresh flows into their arbitrage schemes. ICICI MF has stopped accepting fresh investments till March 31.
“Opportunities in the arbitrage space have reduced drastically, in the Futures market. Under normal conditions, spreads are available in the range of 35-40 basis points (bps), but the spread has currently narrowed to 15-20 bps, with many securities trading at a discount,” ICICI MF said in a note.
The fund house added that investors with a long-term investment horizon may continue to remain invested as this is a “special situation”. “Fresh investors coming into arbitrage schemes would have seen some losses, so it was a prudent move to suspend flows,” said a fund manager.
Industry participants say that arbitrage schemes could still be among the safer products in the market.
“Technically, one cannot make losses in arbitrage schemes, except only to the extent of the fund’s expense ratios, in the worst-case scenario. This is because all positions are balanced out in such funds. Therefore, investors can keep their investments in such schemes, as the dislocation in markets could also reverse, going ahead,” said Jimmy Patel, managing director and chief executive officer of Quantum MF.
The strong recovery in the markets seen over the last three days is positive for arbitrage schemes as it can put futures back to trading at a premium to spot prices of stocks. On Thursday, Tata MF announced that it had re-opened flows into its arbitrage schemes.
Arbitrage schemes have seen sizeable investor flows in the current financial year (FY20). This comes as investors seek pockets of safety, with debt schemes being hit by credit risks. From the beginning of FY20, investor assets have risen 71 per cent — from Rs 50,839 crore to over Rs 87,000 crore.
Year-to-date, arbitrage schemes have given returns of 0.1 per cent. Over a one-year and three-year period, the schemes have given average returns of 5.9 per cent and 5.8 per cent, respectively.