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A equity fund that's like a debt fund: Arbitrage opportunities


How would you like to invest in a fund that gives you:
a) better returns than liquid funds
b) same risk as a liquid fund
c) much better tax treatment than a liquid fund

I can see you raising your eyebrows in suspicion. No this is not a get rich quick scheme, and will not loot you of your money.

You should consider buying an arbitrage fund like SBI Arbitrage Opportunities fund.

Reason: It has given around 2.88% in the last three months, which is higher than liquid funds. Second, the risk profile is like that of a liquid fund – i.e. no capital risk at all, since it invests only in arbitrage opportunities.

Third, the capital gains tax on an arbitrage fund is much better than a debt fund – it is only 10% of your gains if you ditch the fund less than a year, and 0% for more than one year. Reason is: This fund invests in equity arbitrage, so it gets the benefit of an equity fund, with the risk profile of a debt fund.

Firstly let me explain the concept of arbitrage in this case. A stock that is traded in the futures markets – let’s say Infosys – usually has a slightly different price on the futures market versus the cash market. So if the futures price is Rs. 1975, and the cash market price is Rs. 1950, then you can buy in cash and sell the future. That gives you Rs. 25 per share, risk free – regardless of which direction the price moves.

Say the price on the date of expiry is Rs. 2,400 (huge increase). The future sale will be a loss of Rs. 425 per share, but you also sell in the cash market and make profit of Rs. 450 per share. The result: Rs. 25 profit. If the price is Rs. 1600, you make Rs. 375 profit on the future, Rs. 350 loss in the cash market. Still, Rs. 25 profit. So it’s risk free.

That is an example of course; your results may vary. But why can’t you do this yourself instead of going to a fund house? Because the margins required to do this are pretty big – buying a 100 lot (minimum lot size for Infy) in the cash market needs about 2 lakhs of cash, and to sell in the futures market requires about half that. So 3 lakhs, to make 25×100 = Rs. 2500 profit. You may not have that kind of capital available.

In the last few months arbitrage funds have made about 9-10% annualised, and the tax benefit allows you to get a better return. If you invest in a liquid fund, it would give you around 9% annualised, purely because dividend tax is high (around 28%) and capital gains tax is around 30% (your investment bracket). Taking 30%, your net return, if you want to exit within a year, is around 6.3%.

Arbitrage funds, being equity funds, allow you to get a better capital gains tax – which is 10% short term, and 0% long term – and that means a 9% return translates to a 7.85% return within a year. (including 0.25% STT)

What’s the downside? (There is always a downside)

You can buy this fund anytime but you can redeem or sell it only on the last thursday of the month (futures expiry date). If you give your redemption order before that, you will money only on that date or a couple of days after it. It’s not as liquid as a liquid fund, but if, like me, you are ok with getting your money at the end of the month, you should be ok.

There is no entry load. There is an exit load if you exit before six months – typically 0.25% or so. Also there is STT applicable, again, 0.25%. Even if you consider that you make more money with arbitrage funds, with the same low risk, than liquid funds. You sacrifice a little liquidity, and your returns are not guaranteed.

This may even be better than long term FMPs, which give you the above advantages of lower tax since they span financial years, but you have to hold till maturity (or pay a large penalty).

Links: SBI Arbitrage Opportunities fund

Also read Money Today’s informative article.


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