mutual fund<\/a> <\/strong>that seeks to profit from price discrepancies between different markets. This is achieved by engaging in the simultaneous purchase and sale of securities in various markets, thereby seizing the price difference as a source of profit. For example, an arbitrage fund might buy a stock in the cash market and sell it simultaneously on the futures market if the futures price is higher than the cash price. This is possible due to the occasional lack of perfect alignment between the futures and cash markets, which results in transient price disparities between the two.<\/p>\n\n\n\nThese funds are commonly considered a comparatively low-risk investment due to their minimal dependence on the stock market’s overarching trend.<\/p>\n\n\n\n
Example<\/h3>\n\n\n\n Let\u2019s understand the workings of an Arbitrage fund with the help of an example.<\/p>\n\n\n\n
Suppose a stock is trading at INR 100 in the cash market. In the futures market, the same stock might be priced at INR 105 with delivery in a month. An arbitrage fund can buy the stock in the cash market for INR 100 and simultaneously sell the same stock in the futures market for INR 105 (locking in the contract).<\/p>\n\n\n\n
Upon the futures contract expiration after a month\u2019s duration, the fund proceeds to fulfil its obligation by delivering the corresponding stock.<\/p>\n\n\n\n<\/span>Taxation in Arbitrage Funds<\/span><\/h2>\n\n\n\nArbitrage funds are taxed like all other equity funds in India. Below is a breakdown of their taxation implications.<\/p>\n\n\n\n
\nShort-Term Capital Gains (STCG)<\/strong> \u2013 if you sell arbitrage fund units within one year of buying, the gains are considered STCG and are taxed at a rate of 15% plus any applicable surcharge or cess.<\/li>\n\n\n\nLong-Term Capital Gains (LTCG)<\/strong> \u2013 if you hold your arbitrage fund units for more than one year before selling, the gains are considered LTCG. The taxation for LTCG is as follows: up to INR 1 lakh of LTCG earned in a financial year is exempt from tax. Gains exceeding INR 1 lakh are taxed at a concessional rate of 10% plus surcharge and cess.<\/li>\n<\/ol>\n\n\n\n<\/span>Benefits of Arbitrage Funds <\/span><\/h2>\n\n\n\n\nLow Risk<\/strong>: These funds are widely considered to be among the less risky investments within the mutual fund category because they capitalize on price variations rather than relying solely on the general direction of the market.<\/li>\n\n\n\nSteady Returns<\/strong>: Arbitrage funds can generate consistent returns, even in highly volatile markets, by effectively capitalizing on short-term price inefficiencies. This can provide a buffer against market fluctuations and offer a relatively more consistent source of income.<\/li>\n\n\n\nLiquidity<\/strong>: These funds are highly liquid, so you can easily buy or sell your units on the exchange, allowing quick access to your invested capital.<\/li>\n<\/ol>\n\n\n\n<\/span>Risks of Arbitrage Funds<\/span><\/h2>\n\n\n\n\nLow Return<\/strong>: The arbitrage opportunities these funds explore usually involve minor price discrepancies. Despite their consistency, their overall returns may be lower than those of alternative, potentially riskier investments.<\/li>\n\n\n\nHigh Expense Ratio<\/strong>: The active management style and frequent trading involved in arbitrage funds strategies can lead to higher expense ratios compared to passively managed index funds. <\/li>\n<\/ol>\n\n\n\n