Rich investors and family offices have put in ₹3,712 crore in arbitrage funds in April, making it the highest monthly inflow into this category in 12 months, The Economic Times reported.
Financial planners recommend arbitrage funds to investors for short-term needs of a month to six months, since they are likely to offer around 7 percent returns with better tax efficiency than liquid funds.
“Given the attractive spreads and higher interest in equities, arbitrage funds can deliver a 7% return. These returns are similar to liquid funds with better tax efficiency,” said Viral Bhatt, founder of Money Mantra.
Fund managers attribute the rising interest in arbitrage funds to improving sentiment in the equity market that they said led traders to increase their bets and take higher leveraged positions.
“Improving sentiment in the equity markets, a far lower quantum of money chasing arbitrage compared to a year ago, and a rise in interest rates have led to higher returns from arbitrage funds,” said Bhavesh Jain, co-head, hybrid & Solutions at Edelweiss Mutual Fund.
Lower returns had led to outflows in the arbitrage fund category with assets now falling to ₹81,242 crore compared to its peak of ₹1.15 lakh crore a year back.
This coupled with a dip in Nifty valuations, saw balanced advantage funds redeem their arbitrage allocations and move to equity.
There were also significant outflows in March to take advantage of the capital gains tax in debt funds, leading to outflows from arbitrage funds.
“The Nifty PE, which was 28 a year ago, has fallen to 18 now, making balanced advantage funds to increase their equity exposure and reduce arbitrage positions, resulting in lower money in the category,” said Jain.
Arbitrage funds benefit from the price difference between the cash and the futures market. These schemes earn a spread by buying in the cash market and selling in the futures market. They allocate a minimum of 65 percent of the portfolio to arbitrage strategies, with the fund manager having the flexibility to allocate the balance of 35% to fixed income.
As arbitrage funds enjoy equity taxation, investors prefer it for higher tax efficiency. Investors holding such a fund for less than a year pay a 15% capital gains tax.
If they sell after a year, they pay only 10 percent as long-term capital gains tax, which results in higher post tax returns.