Arbitrage Funds

We have heard of different types of mutual funds and during that conversation sometimes you hear arbitrage funds or you might not have heard of it at all. What are Arbitrage Funds? To understand Arbitrage funds let us go to the definition of Arbitrage. Arbitrage means buying a product in one market and selling it in another to make a profit due to the difference on price.

So now that we know what arbitrage means how does it apply to the stock market? In the stock market trades are done in cash or future and the price in both these are different. In such a case, if the price in the future market is higher than the cash price, one can purchase the stock in cash today and deliver it in the future market at a higher price and make a profit.

That means if we invest in these funds you will never lose your capital. Then why have arbitrage funds not caught up. One reason is, the profit will take place only on a future date and if you want to exit in between there could be a chance of loss. This chance of loss is what is holding people back. But if you are ready to wait for some time, the returns are good, even better that debt funds.

Arbitrage funds are good in a rising market, as the future prices will most of the time be higher. So keep a watch on the cash and future prices of around 10 stocks and if you see the average difference reducing, it’s time to move out of the arbitrage fund.

The other advantage in arbitrage funds is taxation. Since they are mostly equity funds and for equity funds there is no long term capital gain. Even in case of short term capital gain, the tax is just 15% of the capital gain. This is better than debt funds where short term capital gain is taxable as per your tax slab.

So if you are looking at short term, arbitrage funds are better than debt funds, but for long term, equity funds are the best.