The arbitrage fund category serves as a strategic avenue for investment to allocate their surplus funds. Primarily, these funds aim to capitalize on arbitrage opportunities arising from price differentials between a stock’s price and its price in the futures market.
In most market scenarios, this price differential, known as the spread, mirrors the prevailing money market interest rates. Consequently, arbitrage funds are often considered suitable investment vehicles for horizons exceeding three months.
Arbitrage, as a concept, entails simultaneously buying and selling an asset across different markets to exploit price differentials and generate profits. This strategy leverages the spread between asset prices, which forms the basis of returns for arbitrage funds.
Comparing Liquid Funds and Arbitrage Funds
While the recommended investment horizon for arbitrage funds is typically three to six months, investors often find themselves deliberating between liquid funds and arbitrage funds due to the relatively low risk associated with both, especially within the mentioned investment horizons.
However, the objectives of these fund categories differ within an investor’s portfolio. For investments spanning a minimum of three months, arbitrage funds may be more suitable. Conversely, liquid funds are preferable for shorter investment horizons, typically ranging from seven to 91 days.
Tax Considerations
Short-Term Capital Gains (STCGs) from investments held for 12 months or less in the arbitrage fund category are taxed at 15%, akin to equity-oriented funds. Consequently, post-tax returns from arbitrage funds often prove more efficient compared to certain debt fund categories utilized for parking surplus funds.
Furthermore, the tax efficiency of arbitrage funds becomes more pronounced during periods of rising interest rates. This phenomenon occurs because arbitrage market spreads closely track prevailing interest rates in money market instruments, aligning the returns of arbitrage funds with movements in money market rates.
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