Arbitrage funds opportunities


Imagine being able to buy low and sell high simultaneously and booking profits. Too difficult to believe but it is possible through arbitrage funds offered through Mutual funds.

Arbitrage is an investment strategy that takes advantages of price differentials between two markets. To give a simple example if the stock of company XYZ is trading at Rs 500 on the BSE and at the same time it is trading at Rs 510 in NSE one can buy from the BSE and sell simultaneously on the NSE making a profit of Rs 10. Similarly one can undertake arbitrage opportunities between cash market and derivative market. For instance if the stock of the company XYZ is trading at Rs 1000 in cash market and the futures price of the stock is Rs1040, one can sell the future of the stock and simultaneously buy the stock at Rs 1000 from the cash market to make a risk free gain. However an important caveat is that one must consider the costs of buying and selling while undertaking arbitrage. These costs include Securities Transaction Tax (STT), brokerage etc. Make sure that an arbitrage does not result in a loss due to these costs.

Risks involved

Arbitrage investing does not involve taking risks on specific investment. It does involve the risk of losing the opportunity if the market corrects before the investor makes an exit making profit.

There are 2 specific risks involved in arbitrage investing.

One may not be able to successfully close both ends of the arbitrage transaction. For instance, if you decide to buy 1 lakh shares on one exchange an sell on the other, while you may be able to successfully do the purchase, you may not be able to sell the entire 1 lakh shares on the exchange where the price is higher, due to a lack of buyers. A similar situation could arise while doing arbitrage between the cash and futures markets.

While doing arbitrage between two cash markets – say, BSE and NSE, even if you are able to successfully buy and sell the exact quantity of shares in both markets, you may face delivery problems in the market where you bought, resulting in a lower delivery in the market where you have sold. For instance, if you bought 100,000 shares of Company ABC in the BSE and sell the same amount in the NSE, if you receive only 90,000 shares in the BSE due to sellers in BSE not being able to deliver, you will end up delivering only 90,000 shares to NSE. This short delivery will lead to you being compelled to buy these shares in auction, most likely at a higher price, leading to either reduction in profits, or probably even a loss in the overall transaction.

Tax Benefits

Funds, which maintain the equity component of their corpuses at above 65%, will be treated as equity funds and their investors will be eligible for the tax benefits on such funds (dividend and long term capital gains are tax-free and short-term capital gains attract a flat tax rate of 10%) while the others will be treated as debt funds.

Some of the Arbitrage funds available currently in India,

1. UTI Spread Fund
2. SBI Arbitrage opportunities Fund.
3. Kotak Cash Plus Fund
4. Prudential ICICI Equity and Derivatives Fund
5. JM Arbitrage advantage Fund.

Arbitrage funds are especially suitable for debt investors who would like to diversify the portfolios towards investment strategies, which help optimize returns and which are not equity-oriented.