What is Arbitrage Fund? How Arbitrage Fund works in India?
An Arbitrage Fund is a type of mutual fund in India that aims to generate returns through the exploitation of price differentials in different markets or segments. These funds take advantage of the price inefficiencies that may exist between the cash and derivatives markets, aiming to make risk-free profits.
Here's how an Arbitrage Fund works in India:
Strategy: Arbitrage Funds implement an arbitrage strategy by simultaneously buying and selling securities in different markets to profit from price differentials. They typically take long positions in the cash market and short positions in the derivatives market.
Cash-Futures Arbitrage: The fund manager identifies opportunities where the price of a stock or index in the cash market is different from its corresponding futures contract price. The fund buys the stock or index in the cash market and sells equivalent futures contracts to capture the price differential.
Risk-Free Profits: Arbitrage Funds aim to generate risk-free profits by taking advantage of these price discrepancies. The strategy involves locking in a profit by simultaneously buying and selling the same or similar securities in different markets, ensuring minimal or no market risk exposure.
Hedging: To minimize the risk associated with the arbitrage strategy, the fund manager may hedge the positions by taking opposite positions in the cash and derivatives markets or through other hedging techniques. This helps in reducing the impact of market movements on the fund's returns.
Low Volatility: Arbitrage Funds typically exhibit low volatility compared to other equity-oriented funds since they aim to generate returns irrespective of market movements. They tend to have lower market risk exposure due to their hedged positions.
Shorter Investment Horizon: Arbitrage Funds generally have a shorter investment horizon compared to other equity funds. The positions taken by the fund are typically unwound before the settlement date to realize the price differentials. This allows for quicker turnover of the portfolio.
Taxation: Arbitrage Funds in India are treated as equity funds for tax purposes. Long-term capital gains tax is applicable if the units are held for more than one year, while short-term capital gains tax is applicable if the units are held for one year or less.
Arbitrage Funds in India are regulated by the Securities and Exchange Board of India (SEBI). SEBI sets guidelines and regulations to ensure investor protection, transparency, and fair practices for Arbitrage Funds.
Before investing in an Arbitrage Fund in India, it's important to review the fund's investment objective, historical performance, expense ratio, risk factors, the reputation and track record of the fund house and manager, and consider your own investment goals and risk tolerance. It's also advisable to consult with a financial advisor if needed.
