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Arbitrage Funds – Good Bet in Volatile Markets

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Category:  Market  
| 11-12-2015 11:00 AM

Arbitrage Funds – Good Bet in Volatile Markets

The calendar year 2015 has been a year of consolidation. After seeing the 30K peak the markets have seen a phase of correction amidst the bout of volatility. These volatile conditions have been conducive for specialized theme of mutual funds, known as arbitrage funds. 

Arbitrage is basically buying in one market and simultaneously selling of an asset in another to gain from the temporary price difference. It is considered as a riskless profit for an investor. Arbitrage funds use these price differences and execute the strategies in various segments such as cash-cash, cash-future etc.

Swing Patterns

Before we delve more in arbitrage funds, following is the analysis of daily swing patterns of Sensex.  In CY 2015, Sensex has witnessed the highest 77 sessions of 200-300 points’ swings, 62 sessions in 300-400 points band. In CY 2014, Sensex saw the highest, 91 sessions of 100-200 points’ swings and 88 sessions in 200-300 points band.

Another striking difference in these 2 graphs is, 2015 observed more high range swing sessions (300 to 800 points) vis-à-vis CY 2014. It was a tough fight between 100-200 band and 200-300 band in 2014 but in 2015, 200-300 band gained prominence over others. These conditions are best suited for arbitrage funds and with use of algorithmic trading these index swings might grow leaps and bounds.

Sensex Daily Swings - 2015
Until 09-Dec-15

Sensex Daily Swings - 2014
CY 2014

Arbitrage Funds – a hybrid option

Arbitrage funds are categorized as equity funds (with average exposure of more than 65% of equity) but are comparable to debt funds from the return perspective. They offer a near risk-free return along with tax advantage against debt funds i.e no long term capital gain tax if one holds it for more than 1 year. In case of short term capital gains too, arbitrage funds enjoy a tax advantage over debt funds with the indexation benefit factored-in.

Arbitrage Funds - Returns

Arbitrage Funds Returns – sorted on YTD Performance (as on 9-12-2015)

The above image captures the performance of “Arbitrage Funds” operational in Indian MF scene.  All the funds are yielding positive on YTD basis. The performance of these stocks have also never faltered on other timelines as well with “Reliance Arbitrage” being the consistent performer with returns of above 8%.

On the AUM front, Arbitrage funds basket has more than doubled from Rs 12000 crores of AUM in Jan 15 to around 30000 crores in Nov 15. JM funds leads the pack with Rs 5675 crores of corpus. Most of these funds have an exit load of 0.25% to 0.50% applicable for 90 days tenure.

In a nutshell, investors need to understand the concept of derivatives before investing in any arbitrage fund. It should not be treated as an equity fund aiming for capital appreciation. The returns of these funds are directly proportional to the volatility in equity markets: the more, the merrier.

Exposure to these funds should not be more than 5% to 10% of the overall portfolio. They can be a good investment candidate for short term or as a “parking fund” for long term equity investments as they offer a tax advantage over debt funds.

Raghav Chandak Lead Financial Analyst

Over 7 years of experience with competencies in Financial Data Research & Modeling, Financial Product Development & Management and Financial data distribution.