For example, say they buy Infosys shares @ Rs.1800/share in cash market on Aug 1. At the same time, they will sell Infosys shares in the futures market, which would be quoting for say about Rs.1815 (the difference in financial parlance is called the ‘cost of carry’).

Let’s say the price of Infosys on the expiry date of the futures contract (last Thursday of the month) is Rs.1900. Thus, the fund will make a profit of Rs.100 in the cash market [Rs.1900 – Rs.1800] and loss of Rs.85 [Rs.1815 – Rs.1900] in the futures market. (On the expiry date the cash and future prices are same). The net gain is Rs.15.

Or suppose the price of Infosys drops to Rs.1700. Thus, the fund will make a loss of Rs.100 in the cash market [Rs.1700 – Rs.1800] and profit of Rs.115 [Rs.1815 – Rs.1700] in the futures market. Again, the net gain is Rs.15.

This way, the market movement does not affect them. They earn Rs.15, whatever may be the final price, which in this case works out to about 10% p.a. assured returns (@Rs.15 on Rs.1800 in one month).

In nutshell, arbitrage funds will yield returns more or less in line with liquid funds / floating rate funds or FMPs; and, more importantly, with practically very little risk.

For example, in last 6-12 months’ arbitrage funds have given about 9.25% p.a. average returns, while floating rate funds have given around 7.5% returns, liquid plus funds around 7.9% returns and FMPs around 8.5% returns.

Now, the key point – for tax purposes arbitrage funds are treated as equity funds. Hence, they enjoy lower tax vis-à-vis debt funds (see table below).

Particulars	Arbitrage Funds	Debt Funds
Dividend Distribution Tax	Nil	14.16%
Long Term Capital Gains Tax	Nil	11.33%
Short Term Capital Gains Tax	11.33%	As Per Slab
Securities Transaction Tax	0.25%	Nil

Thus they could give even better post-tax returns than debt MFs.

If the period is less than 1 year, both Debt Funds and Arbitrage Funds will give almost the same returns. At 8% pre-tax returns, the post-tax return works out to about 7%. But, if the period were 1 year, then post-tax yield would be 7.09% in debt funds and 7.73% in arbitrage funds.

Are Arbitrage Funds OK to Invest In?

There are no major risks associated with arbitrage funds unlike market-risk in equity funds or interest-rate risk in normal debt funds.

However, there could be some minor risks. There may not be any arbitrage opportunities available, especially in bearish markets. In such cases, the arbitrage funds will work like liquid funds. Or on the expiry, the rates in cash and futures markets may not match exactly. This could marginally affect the returns. Or there could be some problems in executing the deals due to low liquidity.

Apart from this, one must keep certain points in mind:

• Arbitrage funds usually have an exit load for investment period less than 3 months. So make sure that you won’t need this money for at least 3 months.
  
  
• The returns are linked to expiry of contracts (which happens on the last Thursday of the month). So you need to be a bit careful about your redemption dates.

Concluding, therefore, one can say that arbitrage funds can be a good alternative to invest our short-term money, where we can earn high post-tax returns – with reasonable degree of safety and surety.

Author: Sanjay Matai

(The author is an investment advisor.)