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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.

  • Anoop says:

    >If this fund is taken, then which is the best option – Growth or Dividend. I fall in the 30% tax bracket. I can lock the money for 6 month to 12 months. Will it help to invest the money on my wife’s name???

  • Anonymous says:

    >Just wanted to point out that nil long-term cap gains tax or 10% short-term tax is only available if 65% of the assets are invested in domestic equity shares and the % is determined by the opening and closing balances of the monthly averages. Now, in an arbitrage fund,it would not be certain that 65% is invested in equity. Derivative instruments are not equity. Also, lack or arbitrage opportunites will lead to funds remaining in liquid or money market instruments or cash. So net , net, the tax treatment of an arbitrage fund would be similar to that of a non-equity scheme. — S

  • Deepak Shenoy says:

    >Anoop: I’d say take growth. Dividend distribution tax is 15%, short temr cap gains is 10%, so growth is better.

    Anonymous (S): Not so- they are “equity” funds because they do invest 65% in equities (temporary cash storage is perfectly legal, and they are usually invested more than 65% in equities)

    Check out for confirmation.

  • Deepak Shenoy says:

    >Also note: from the offer document it is clear on page 42 that STT will be levied on redemptions. The Income tax act allows capital gains at equity levels for any redemption of mutual funds that pays STT.

  • Venkateswaran says:

    It is based on the assumption that there is no difference in the price between the Futures and the cash market on the expiry date, right?
    If not, then there is a possibility of not able to lock in the profit (from your example, Rs25 per share).
    What do you say?

  • Deepak Shenoy says:

    >Venkat: By definition the futures price converges with the cash price on expiry. The idea is, at the end of the expiry date, the outstanding futures are automatically squared off against the closing cash price, with buyers and sellers earning (or paying) the difference between the price they entered and the cash price at expiry.

  • Anonymous says:

    >Deeapk,Can you throw light on the liquidity factor on these funds?


  • Deepak Shenoy says:

    >Anshul, as I mentioned:
    You can buy this fund anytime but you can redeem or sell it only on the last thursday of each month (futures expiry date). If you give your sell order prior to that date, it will be sold on that date and money will reach you two-three days after that.

  • Anonymous says:

    >Thanks Deepak,


  • Mayank Shah says:

    >Computech International I heard from an analyst will spike up to Rs.25

  • Anonymous says:

    >dear mr.Shenoy , i liked ths idia very much. i have sufficent cash around 12 lacs. and i am ready for a low return of 10% pm. i want u to please explain this concept in detail. so that i can start working on it. thanking u .i wll be greatful if u kindly sent it to my mail id if possible.