Arbitrage funds may be back in favour after facing big pullouts

Mumbai: Low returns of 3-3.5% from arbitrage funds over the past one year saw rich investors withdrawing ₹20,048 crore from this category over the past three months, with bank deposits or liquid funds gaining traction in the bargain. But with the sharp rally increasing spreads between cash and futures arbitrage, returns from arbitrage schemes are on the rise again.

Added to this, the fact that they enjoy equity taxation, which increases post-tax return, fund managers expect money to start coming back in the next 1-3 months to arbitrage funds.

Arbitrage funds benefit from the price difference between cash and futures market. They earn a spread by buying in the cash market and selling in the futures market. Financial planners point out that many investors who are staggering investments into equities use arbitrage funds as a parking vehicle, due to lower taxation as compared to debt funds.

The sharp rally in the markets, with the Nifty 50 moving up 18% in the last three months, has led to increased activity in the F&O space, thus pushing up spreads.

"With the Nifty 50 nearing its all-time high, there is sharp rise in HNI activity in the F&O space, which is aiding arbitrage returns," says Bhavesh Jain, fund manager at Edelweiss Mutual Fund.

Fund managers point out that the spreads fell to as low as 3.8-4% in June, then increasing to 5-5.25% in July and further rising to 5.75-6.3% in August.

'Rollover spreads have increased sharply over their June levels. Currently, opportunities for rollover range up to 6.3% in many scrips," says Deepak Gupta, fund manager, Invesco Mutual Fund.

After accounting for expenses, fund managers believe investors could earn close to 5.5-5.7% from arbitrage funds, which is likely to trigger back investor interest again.

Tax efficiency is another draw to arbitrage funds. As they enjoy equity taxation, investors prefer it for higher tax efficiency. Investors holding such a fund for less than a year pay 15% capital gains tax. If they sell after a year, they pay only 10% long-term capital gains tax, which results in higher post-tax returns. In a debt fund, if an HNI sells before three years, he has to pay short- term capital gains.