Arbitrage Funds

Arbitrage is a term used to describe the purchase of a product which is then immediately sold to make a profit. Arbitrage is popular in the stock market or as a means to make profit from goods being sold at differing prices in varying markets.

Let’s take an example of arbitrage. Suppose a tailor sells a shirt for Rs. 400/- the cost for him is Rs. 300/- He makes a profit of Rs. 100. One day when he at the cloth manufacturer, he meets another tailor who also makes shirts and sells. The cloth and accessories are the same, his fitting is also more or less similar, but he sells his shirts for Rs.250/- So our tailor to increase his profits, buys from the other tailor at Rs. 250/- and sells for Rs. 400, increasing his profit to Rs. 150/- per shirt. This is arbitrage, basically taking advantage of the price difference in the other market for the same product.

The above type of arbitrage is available in the financial markets as well. In the financial markets there are 2 types of markets, one is cash and the other is derivative. There is always a price difference in both these markets. So if one buys in the cash market and sells in the derivatives market it will be called an arbitrage trade.

Now if it was so easy everyone would have been doing it. But here is the catch. In the cash market you can buy today and sell tomorrow. But in the derivatives market it is a contract which is valid for a fixed period. One just pays a premium initially and at the end of the contract period, s/he has to settle it by paying the difference between the then prevailing price and the contract price. So if your bet goes wrong, you could lose big. But since you have done the opposite in the cash market, the loss will be minimal.

Arbitrage funds returns are very similar to debt fund or fixed deposits, but this product is treated as an equity product. The reason is tax.

Therefore it is very important that you know about the tax treatment and investment options before making any investment decisions.

For income tax purpose, as mentioned above arbitrage mutual funds are classified as Equity oriented funds.

·         Long Term Capital Gains on Arbitrage Fund

      o   If you make a gain / profit on your investment in an Arbitrage Mutual Fund scheme that you have held for over 1 year, it will be classified as Long Term Capital Gain.

      o   The long term capital gains on Equity oriented funds will be taxed at 10% if the total Long Term Capital gains is more than Rs. 1 Lakh in a year. It is tax free till March 31, 2018.

·         Short Term Capital Gains

   o   If your holdings of an Arbitrage Equity mutual fund scheme are less than 1 year old i.e. if you withdraw your mutual fund units before 1 year, after making a profit, then the profit will be considered as Short Term Capital Gain.

      o   The capital gain tax rate of 15% is applicable on Short Term Capital Gains of Arbitrage Fund.

   o   Kindly note that interest income on Fixed Deposits will be charged at as per your income tax slab rate.

   o   The Short term Capital gains on Debt mutual funds too are taxed at as per your income tax slab rate if the holding period is less than 3 years.

So, as per the current tax laws, the Arbitrage Funds have clear tax advantage over Fixed Deposits or Debt Mutual Funds.

 

 

How to make your money grow

We start investing in a small way and slowly and steadily we build a good corpus, but all this was not easy. We might have burnt our fingers on the way. If you had taken the help of a financial advisor the journey would have been less painful. Never the less, we have to learn and that is the only way to grow.

First thing to remember is always invest in an asset class based on your goal and time horizon. Many people I have met, just invest based on the past returns of a particular asset class. All asset classes have their own ups and downs and nobody can say for sure, when is the right time to invest in a particular class of asset. Some like gold, others like fixed deposits and others like equity. But investment in a particular class of asset should always be based on goal and time horizon. It should not happen that when you actually need the money, the market for that particular class of asset in which you invested is down.

Next to remember is when it comes to investment you need to have discipline. Do not go by rumors or market movements. If you have invested with a particular time horizon and nothing has fundamentally changed, stick to your course.

For those who are risk averse and prefer FD’s, please check the credit rating before investing. Many companies give interest which is higher than the market rate of interest. They are ready to give those rates as nobody else is ready to give them money. Go for AAA rated fixed deposits only.

Always have a plan for your investments. If you do not have a plan you will find it difficult. Before you start your investment plan, make a contingency plan, basically your investments plan should not be derailed just because of some untoward incident. So get your insurances in place, be it health or life or even house. Any plan made should take into account taxes. What is the point of making money and giving most of it away in taxes.

Last but not the least, monitor your investments on a regular basis.