Arbitrage Mutual Funds have started gaining lot of popularity since 2014 and have become the “Apple of Investor’s eyes” who are seeking a risk free return on their investment. In this article, we would be focussing on What are Arbitrage Mutual Funds and should you as an Investor be investing in Arbitrage Mutual Funds.
Many Investors have now started investing in Arbitrage Mutual Funds especially after Budget 2014, wherein the finance minister Arun Jaitley changed the manner of taxability of Debt Mutual Funds. There were several tax benefits available to Debt Mutual Funds before 2014 which have now been taken away.
As Debt Mutual Funds are no more lucrative as they don’t offer tax benefits like they used to do earlier, many smart investors have now started investing in Arbitrage Mutual Funds as such funds offer a risk-free return and there are several tax benefits of investing in such schemes as well.
- Recommended Read: Tax on Debt Mutual Funds in India
What are Arbitrage Mutual Funds?
The term arbitrage means buying in 1 market and simultaneously selling in another market to make use of temporary price difference in 2 markets. This can be explained with the help of an example.
Say for example: You may buy 100 kg of apples at Rs. 150/kg from Himachal Pradesh and simultaneously sell it for Rs. 151 per kg in Mumbai. It is important to note here that both the transactions are entered simultaneously.
As the buying and selling happens simultaneously in such trades, there is no time risk involved of the prices going up or down. Therefore, such trades are considered as risk free. It is also important to note here that the difference between purchase and sale price is very small and therefore the profit is very less.
Arbitrage Mutual Funds also act in the same manner as explained above and do arbitrage on the equity share markets. They buy shares from one market and they sell them in another market to take the benefit of price differences. They also buy in cash market and sell in future markets and make gains through such arbitrage.
The profit is very minimal on each trade and therefore the arbitrage mutual funds enter into hundreds of trades every year so as to earn a decent profit.
Tax on Sale of Arbitrage Mutual Funds
Arbitrage Mutual Funds invest a major chunk of their investments in equity shares and are therefore considered as a part of equity mutual funds. As these are considered as a part of the equity mutual funds, they also get the tax benefits available to other equity mutual funds i.e.
- In case of Long Term Capital Gains i.e. if the Arbitrage Mutual Fund is held for more than 1 year – Tax would be levied @ 10% w.e.f Financial Year 2018-19.
- In case of Short Term Capital Gains i.e. if the Arbitrage Mutual Fund is held for less than 1 year, they capital gain tax would be levied at a flat rate of 15%.
- Recommended Read: Tax on Sale of Mutual Funds
As there are several tax benefits available to such mutual funds, they are liked by a lot of people looking for safe and tax free investment options.
Returns of Arbitrage Mutual Funds
The difference in the prices of a product in 2 different markets is usually very less. Therefore, the arbitrage mutual funds enter into hundreds of transactions every year so as to earn a decent profit. Moreover, as the buying and selling happens simultaneously, therefore is no risk as the product has already been sold.
Although these type of mutual funds don’t offer any guaranteed returns, the returns usually vary in the range of 8-10% every year.
It is usually when the share markets are volatile that there are arbitrage opportunities and therefore the returns tend to be higher in years when the markets are volatile.
The higher the volatility – the higher would be the return, the lower the volatility – the lower would be the return. In normal periods of volatility – the return is expected to be in the range of 8-10%.
Comparison of Arbitrage Mutual Funds vis-a-vis Fixed Deposits
If you are planning to invest in a safe income earning instrument, the most popular option available is Fixed Deposits. A comparison of Fixed Deposits and Equity Mutual Funds has been detailed below for your ready reference.
|Particulars||Arbitrage Mutual Fund||Fixed Deposits|
|Return on Investment||8-10% (expected)||8-9% (Guaranteed in Advance)|
|Tax on Earnings||Tax Free if held for more than 1 year. 15% Tax if held for less than 1 year.||30%|
|Effective return of investment after Tax||8-10%||5.6% – 6.3%|
|Complexity Level||A bit complicated for Layman to understand||Very easy to understand for Layman|
|Suitable for||1-2 years of investment with tax-free returns, high liquidity and better returns than savings bank||A person looking for 100% surety and No or very less income tax is payable on his income.|
*The above chart has been prepared assuming that the investor is in the highest slab rate.
Should you be Investing in Arbitrage Mutual Funds?
If you are in the highest tax slab rates i.e. 30%, the arbitrage mutual funds will certainly give you a better return on investment as compared to fixed deposits. However, if Nil or Low Tax is applicable on your total income for the year – you can think of investing either in Fixed Deposits or investing in Arbitrage Mutual Funds.