Tuesday, August 19, 2014

Arbitrage funds

Arbitrage fund, the lesser known product category has suddenly come to the limelight after the changes in the taxation structure of the debt oriented mutual funds. Recently, a mid-sized mutual fund galloping INR 5400 crores in a span of 2 – 3 weeks in their arbitrage fund has raised the eye brows of the industry players.
By definition, arbitrage is a financial transaction that has no or minimal risk.Arbitrage equity funds employ such strategies to take advantage of the price differential of a security between the exchanges, cash and the derivatives segment.
These funds simultaneously buy shares in the cash segment and sell futures (derivatives segment) of the same company as long as the futures are trading at a reasonable premium. On expiry, the cash and futures price coincide thus leading to positive returns for the investor. Such funds do not take a naked exposure to equities as each buy transaction in the cash market has a corresponding sell transaction in the futures market. Hence, the portfolio is generally neutral unlike a long only equity fund. This strategy helps the scheme generate almost risk free equity return in line with the liquid fund/ money market mutual funds.
The shortcomings in this product are manifold. At the outset, the arbitrage opportunities are far and few. In the absence, the fund would mimic the portfolio of a liquid/money market mutual fund. Here lies the trick; As per the provision of Sec. 10(38),  an equity oriented fund is defined  that which not only invests in equity shares of the domestic companies to the extent of more than 65% and suchpercentage to be computed with reference to the annual average of the monthly averages of the opening and closing figures.  Hence, the tax treatment of an arbitrage fund could vary subject to the fund fulfilling the aforesaid criteria due to market considerations.
1.       In case the allocation to equity is above 65%&above : the tax treatment will be similar to that of Equity Scheme 
2.       In case the allocation to equity is 65% or below:the tax treatment will be similar to that of Debt Scheme.

If you’re investing in these funds to take advantage of the equity taxation,(ieno long-term capital gain tax if held for more than a year and no dividend distribution tax) you need to re think. In addition, some of the arbitrage funds have mandate to invest a small portion of the portfolio in buybacks, open offers, delisting, takeover bids, mergers and IPOs. This could add to the volatility of returns from these funds.As the devil lies in the detail, Investors should read the fine print before investing.

Disclaimer: No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments

No comments:

Post a Comment