Arbitrage funds in 2024: Currently, tremendous volatility is being seen in the market. Amidst this upheaval, there is an atmosphere of panic among investors. According to experts, the domestic market may remain volatile in the near future amid uncertainty in the global economy regarding the policies of America’s newly elected President Donald Trump. Indications of this are also coming from India Volatility Index i.e. India VIX (India Volatility Index). India VIX has strengthened by about 14 percent so far this year. At present it is above 16. This index reflects potential market fluctuations in the near term.
How to take advantage of this volatility,
In this period of ongoing turmoil in the market, investors do not need to panic because there is an investment option for them where volatility is used to generate returns. This option is- Arbitrage Fund. These funds come under hybrid mutual fund category.
In 2024 these funds did Best performance in 9 years
Arbitrage funds gave the highest returns in the last year i.e. 2024 after 2016. According to Value Research data, funds in this category gave an average return of 8 percent last year. The performance of these funds was so excellent due to the positive sentiment created about the market, tremendous enthusiasm among investors regarding stock futures and huge fluctuations that came after September. Investors did not shy away from paying higher premium during futures rollover last year. His enthusiasm can be gauged from the fact that during 2024, the open interest in stock futures has crossed the record level of Rs 400 lakh crore.
Other data also shows the growing interest of investors towards arbitrage funds. The total asset under management (AUM) of funds in this category crossed Rs 1.96 lakh crore in December 2024. This is 46 percent more than 2023. The asset under management of these funds was recorded at Rs 1.34 lakh crore in the year 2023. Investors infused a net Rs 67,589.59 crore in these funds during 2024. During January, February, April, May and July, the net inflow crossed the level of Rs 10 thousand crore. However, after the spectacular inflows of October, investors withdrew money from these funds in November and December.
Changes in tax rules first increased enthusiasm but later disappointed
After changes in tax rules regarding debt funds, investors were very enthusiastic about arbitrage funds during the first half of the last calendar year. According to the budget provisions, the old provision of long-term capital gains (LTCG) tax along with the benefit of indexation on debt funds has been removed from April 1, 2023. Meaning, whatever capital gain you make from debt funds will be considered as short-term capital gain which will be added to your income and you will have to pay tax as per your tax slab. After these changes, arbitrage funds became more favorable than debt funds in terms of tax.
But after the short-term capital gains tax (STCG) rate was increased by 5 percent in Budget 2024, these funds are no longer as attractive for investors from tax point of view. After July 23, short-term capital gains tax on these funds will be levied at the rate of 20 percent, whereas earlier it was levied at the rate of 15 percent. People generally invest in these funds for 6 months to a year, so most investors have to pay short-term capital gains tax after redemption. But if investors invest in debt funds for the same period, then they have to pay short-term capital gains tax as per their tax slab. This means that in terms of tax, arbitrage funds are now better than debt funds for only those investors who fall in the upper tax bracket.
Now let’s talk about this fund.
What is Arbitrage Fund?,
Arbitrage funds are a better investment option for investors who want to take less risk in times of market fluctuations. These hybrid funds come under the category of equity mutual funds in terms of tax treatment. This means that at least 65 percent of the investment is in equity while the rest is invested in debt and money market instruments.
Arbitrage funds generate returns by taking advantage of the difference in the price of a share in the cash and futures (derivatives) segments of the equity market. During volatile periods in the stock market, the difference in prices i.e. spread between the two segments increases. When market volatility increases, these funds give higher returns but when volatility decreases, the returns also decrease.
How to Arbitrage Fund does the work ,
In this, shares are bought from one segment at a lower price and sold at a higher price in another segment. This can be understood with the help of an example.
Suppose the price of a share of a company is Rs 100 in the cash segment and Rs 105 in the future/derivative segment. At this price (arbitrage) the fund manager buys 100 shares of the company (100X100 = Rs 1,000) for Rs 1,000 in the cash segment and sells them in the derivative segment for Rs 10,500 (105×100 = Rs 10,500). In this way the fund manager makes a profit of Rs 5 per share i.e. a total profit of Rs 500. Provided that at the time of expiry of the future contract, the share price in cash and derivative segments remains the same.
But suppose at the time of expiry of the futures contract, the share price falls to Rs 95 in the cash segment and Rs 90 in the derivative segment. If this happens, there will be a loss of Rs 5 per share i.e. Rs 500 in the cash market, while there will be a total profit of Rs 15 per share i.e. Rs 1,500 in the derivative segment. That means the fund manager will make a net profit of Rs 1,000.
In this way the arbitrage fund takes advantage of the difference between the prices in the cash segment and the future segment.
What is the tax provision,
These funds fall under the category of equity mutual funds in terms of tax treatment. Therefore, tax on it is also same as on equity. Here we will talk about tax provisions in both its option growth and dividend:
Growth Option: If you redeem in less than a year, the income will be treated as short-term capital gain and you will have to pay short-term capital gain tax at 20% (plus 4% cess). But if you redeem after one year, the income will be treated as long-term capital gain and you will have to pay long-term capital gains tax at 12.5% (plus 4% cess) on capital gains above Rs 1.25 lakh annually. No tax will be payable on capital gains of less than Rs 1.25 lakh. Before July 23, 2024, the rates of short-term capital gains tax and long-term capital gains tax were 15 percent and 10 percent respectively, while there was a provision for tax exemption on capital gains up to Rs 1 lakh annually.
Dividend Option: The dividend received from arbitrage fund is added to the income of the investors and investors have to pay tax on that dividend as per their tax slab.
What do experts say?
Arbitrage funds also have some risks and limitations“When the spread between spot and futures narrows or futures trade at a discount, fund managers may hold cash or invest in less risky debt instruments, which could impact returns,” says Kaustubh Belapurkar of Morningstar. ‘
Arun Kumar of FundsIndia said that when there is a downward trend in the market or there is range bound trading in it, then the returns can be negative. Although Arbitrage Funds generally give positive returns in 3-6 months.
tax benefit Arbitrage Making the fund an attractive option compared to debt funds. Kumar believes that Arbitrage The fund is most beneficial for investors falling in the 30 per cent tax bracket, also beneficial for those falling in the 20 per cent tax bracket but less beneficial for those falling in the 10 per cent bracket. Investors falling in such 10 percent bracket can give preference to liquid funds.