Should you bet on arbitrage funds?
ARBITRAGE FUNDS are those that derive returns from the arbitrage between the future and the cash market. They can prove to be reasonably safe as these funds mainly invest in arbitrage opportunities and do not take any credit-bets. In the case of arbitrage funds, greater the volatility, more the opportunities. However, if the volatility slides, these funds can fail miserably. Thus, there is a regulatory mechanism in place, which makes these funds reasonably safe.
As arbitrage funds are LOW RISK investment products, the risk-returns payoff is similar to that of liquid funds. If we compare the returns with that of liquid funds, then on a trailing basis, liquid funds have successfully outperformed arbitrage funds. Even most of the other short-term debt funds such as money market funds, short-duration funds and ultra-short duration funds performed better than arbitrage funds.
In terms of taxation, the tax treatment of arbitrage funds is similar to that of equity funds. However, at times, there are not enough arbitrage opportunities available due to which they have to invest in fixed-income securities. Hence, if in case they invest beyond 35 per cent in debt or debt-oriented securities, they may not be eligible for advantageous taxation like equity funds and such a situation creates problems. Therefore, one should be very careful while investing in arbitrage funds.
Further, if you don’t fall in the highest tax bracket, you can certainly avoid investing in arbitrage funds. Those who wish to invest in them should not park the whole sum in arbitrage funds. Rather, divide it equally among arbitrage and debt funds. Even those who are retired and need to park lump-sum amounts for systematic withdrawal can consider part investment in arbitrage funds and part in debt funds. This would help in getting tax-efficiency.
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