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What are Arbitrage Funds?


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One of the crucial aspects of investing can be taking advantage of the price difference. This can be applicable for various assets, such as stocks, debt, commodities and more. Now, what about taking advantage of this price difference of an asset in different markets? Here's an example:

Consider that you buy a stock at ₹300 on BSE and then instantly sell it on NSE at ₹303. Here, you earned ₹3 extra. Another example of arbitrage can be buying undervalued stocks of an Exchange Traded Fund (ETF). You can earn a profit through the index arbitrage by redeeming the stocks instantaneously. Through an arbitrage fund, you can also buy stocks in the cash market and then simultaneously sell them in a futures market at a higher price.

The key point to notice in the above examples is as follows:

  • Taking advantage of the price difference
  • Actively or simultaneously buy and sell assets

Therefore, you can say that arbitrage funds are mutual funds that take advantage of short-term price volatility by simultaneously buying and selling securities.

Here are a few essential characteristics of arbitrage funds:

1. Hybrid Funds

Technically, arbitrage funds fall under the category of hybrid or balanced funds. Therefore, they invest in both equity and debt instruments.

However, the long-term capital gains from these funds are taxed like the equity funds since a major proportion of the fund is equity.

2. Shorter Investment Horizon

Initially, in this piece, we discussed arbitrage funds. We understood that taking advantage of a short-term price difference is its core.

Arbitrage funds are suitable for short term goals. Though they are equity-based funds and short-term volatility can be an integral part of their core, these funds are all about benefiting from these movements. Therefore, they are less risky than other equity-based funds.

3. Benefit through Volatility

Understanding and experiencing market volatility can seem daunting to investors. However, arbitrage funds are mutual funds that specialise in taking advantage of the same. Therefore, with these funds, investors can have a chance to benefit through the quick rise and plunges.

However, their dependents on short term price fluctuations can also become their limitation during certain market conditions.

4. Higher Expense Ratio

The arbitrage fund's fund manager can typically look for arbitrage opportunities since these can impact the fund's returns. In the absence of such opportunities, they can invest in debt or cash-based securities.

The fund is an actively managed fund with an extensive market watch. Therefore, the TER or Total Expense Ratio of these funds is on the higher side.

Arbitrage funds can be a suitable addition to your portfolio if you are looking for gaining an advantage of short-term volatility and have a lower risk appetite.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully

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