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Saturday, July 5, 2014

Arbitrage Funds Give Tax Efficient Returns to Investors

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Arbitrage Funds to Give Tax-efficient Returns to Investors





Experts advise individuals to park their money in these schemes in the current market as dividend & long-term capital gains are tax-free

Many experts recommend investing in arbitrage funds as they feel that the current market conditions are ideal for these funds. Arbitrage funds try to exploit the arbitrage opportunity or the difference between the prices of securities between different market segments. There are eight arbitrage funds currently available in the market. Edelweiss and L&T funds have just launched their new fund offers (NFOs) in June.

According to Value Research, a mutual fund tracking firm, arbitrage fund category has given an annualised return of 9.18% in the last year. Investors looking for tax efficient returns with a time frame of more than three months can consider these funds.


How Arbitrage Works?


Mutual fund managers say that arbitrage opportunities could arise as cash/futures arbitrage or dividend arbitrage. There is an arbitrage opportunity when there is a price difference of the same asset between the cash and the futures market or between different exchanges in cash market. The price difference between the cash and the futures market converges when the contract expires at the end of the month.

For example, a fund manager can buy 1000 shares of Syndicate Bank in the cash market at ` . 160, and . 161.75, earn sell the same in the futures market at ` ing a spread of `. 1.60 or 1.12%.

The fund manager has the opportunity to reverse the trades anytime during the month, when he feels the profit is maximum or till the contract expires. Assuming the trades are reversed on expiry day, after subtracting broking and STT expenses of approximately 0.33%, the trade generates a profit of 0.79%, resulting in an annualised return of 9.48%.

Dividend arbitrage opportunities arise when a company announces the dividend amount or the dividend date. Based on the past years history of dividend pay out, the fund manager takes a position, to earn a spread. If it works in his favour, he earns a higher return. However, if the dividend is delayed and goes to the next month, he earns a normal spread.


Arbitrage versus Liquid Funds While arbitrage funds and liquid funds both carry a blue colour code, which indicates that the principal is at low risk, experts suggest that they are not the same. Stock prices converge only on expiry day and can be volatile in the interim till that happens.

This makes arbitrage funds volatile, and they could even move down in the interim period as the NAVs are declared on a mark to market basis. While liquid funds can be bought for a time frame of even a day, investors should have a time frame of at least one to three months for arbitrage funds,. This is why most arbitrage funds have an exit loads. For example, IDFC Arbitrage Fund charges an exit load of 0.25% for 90 days, while Edelweiss Arbitrage Fund charges 0.5% for 90 days.

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