Retail investors, who have some liquidity which they don’t want to invest in the current volatile phase, may put it in arbitrage funds.
“Over the long term, you can expect arbitrage funds to give at least 50 basis points higher return than liquid funds. Even if returns are similar to liquid funds, investors will still enjoy better post-tax returns in these funds,” says Singh.
Prasunjit Mukherjee, chief executive officer of Plexus Management Services, explains that while short-term capital gains from liquid funds are taxed at the investor’s slab rate, an arbitrage fund is taxed at 15 per cent, which is advantageous to investors in a higher tax bracket. If arbitrage funds are held for more than a year, the tax rate falls even lower to 10 per cent (for capital gains above Rs 1 lakh).
Volatility in these funds may have subsided for now. But what if it recurs? Experts say the chances of making a loss are extremely low in these funds. “The fund manager locks in the returns in these funds. They buy the stock and short the future when the latter is trading at a premium. Intra-month volatility can exist. But as long as the fund manager holds these instruments till the end of the month, he earns the expected returns,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Advisers India.
The key risk in this category, according to him, is that sometimes there are not enough opportunities to make these kinds of trades. “If the premium in the futures market is insignificant, compared to the spot market, returns can be lower in a particular month. But under normal market conditions, you can expect to make a reasonable return, equal to the cost of carry,” he says.
Investors may use these funds to earn liquid-plus returns at very low risk, with equity-like taxation. “In liquid funds, returns accrue with greater consistency. In arbitrage funds, there can be greater variation in month-on-month returns. But if you hold them for nine-12 months, you should do better,” says Belapurkar.