Investment Trends in Arbitrage Funds: A Closer Look
Investment in arbitrage funds witnessed a significant downturn in August, plunging by 80%. Despite this shift, other hybrid mutual funds experienced a surge in investments during the same month. Industry data reveals that only ₹2,372 crore flowed into arbitrage funds in August, bringing the total investment for 2023 (up to August) to about ₹65,000 crore. This sharp decline raises the question: Is the appeal of arbitrage funds diminishing in the current investment climate?
Understanding Arbitrage Funds
Arbitrage funds are a type of mutual fund that capitalizes on price discrepancies between the cash and futures markets. They typically buy shares in the cash market and sell equivalent shares in the futures market simultaneously. Upon expiry of the contracts, positions are reversed. The profit stems from the difference in pricing between these two markets. Over the long term, the returns from arbitrage funds tend to mirror the yields of money market instruments, making them an attractive option for conservative investors.
Tax Implications of Arbitrage Funds
Changes in tax regulations can significantly influence investor behavior. Recently, the government increased the tax on short-term capital gains (STCG) on equities and equity mutual funds from 15% to 20%. Since arbitrage funds fall under the category of equity funds (due to a minimum of 65% of their assets being invested in equities), this tax change has impacted their attractiveness. Despite likely delivering returns higher than traditional bank savings accounts, these tax adjustments may deter investors who are sensitive to short-term capital gains taxation.
Impact of Tax Rule Changes
Pankaj Shrestha, Head of Investment Services at Prabhudas Lilladher Capital, noted that the allure of arbitrage funds has diminished due to the increased short-term capital gains tax. This change has narrowed the tax benefits traditionally associated with arbitrage funds relative to debt funds. On the other hand, capital gains from debt mutual funds are subject to the investor’s applicable tax slab, regardless of the holding period, making them less favorable for short-term investors.
Current Performance and Returns
As of now, there are 28 distinct arbitrage funds available in the market. The average return over the past year has been recorded at 7.36%. Notably, the Kotak Equity Arbitrage Fund has reported the highest returns, while the Mahindra Manulife Arbitrage Fund has yielded the least. Market experts suggest that global monetary policies, particularly those from the U.S. Federal Reserve and the Bank of Japan, can significantly impact the performance of these funds.
Should You Invest in Arbitrage Funds?
Experts recommend that if interest rates are further reduced, it could lead to diminished returns from arbitrage funds. Interestingly, Vishal Dhawan from Plan Ahead Wealth Advisers argued, “Even with potential declines, arbitrage funds still offer superior tax advantages over debt funds, particularly for high-income investors.” However, it’s advised that potential investors should consider maintaining their investment in these funds for an extended period to fully capitalize on their tax benefits and potential returns.
Conclusion
While the recent dip in investments may indicate a fleeting decrease in interest for arbitrage funds, their unique structure and tax benefits continue to provide relevant options for investors, especially in higher tax brackets. Keeping an eye on interest rate trends and continued market conditions will be essential for any investor considering arbitrage funds as part of their portfolio strategy.
