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What Is An Arbitrage Fund & Who Should Invest?

Arbitrage funds can be difficult to understand. This blog contains a simple explanation of how an arbitrage fund works. We’ll also look at the returns generated by an arbitrage fund compared to other mutual funds.
January 11, 2021

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Products are valued differently in different markets. The price difference across markets & geographies can be used to generate profit. That’s the underlying principle of an arbitrage fund. 


Let’s simplify arbitrage funds and tell you how the fund works to deliver returns for its investors. Along the way, we’ll also take a look at what “arbitrage opportunities” mean. 


Read on till the end of the blog to see the arbitrage funds currently being recommended by Cube Wealth’s Mutual Fund Advisor, Wealth First. 


Let’s begin by answering the question, what is an arbitrage fund?


What Is An Arbitrage Fund?


An arbitrage fund is theoretically a hybrid or balanced fund. This implies that an arbitrage fund invests in both debt and equity. But equity investments represent at least 65% of the fund’s portfolio.


Arbitrage funds leverage stock price differentials to generate returns. This is known as an arbitrage opportunity. Usually, the stock price differential is very low so the fund manager has to trade frequently.


How Does An Arbitrage Fund Work?


There are two primary avenues that offer arbitrage opportunities. Let’s look at each avenue in more detail. 


Arbitrage Opportunity #1: Spot And Futures Markets


The fund manager may buy stocks in the spot market and sell them on the futures or derivatives market for a profit. 


The spot market (cash market) is the regular stock market where you buy stocks based on the present cash value of the share. For example, the price you’ll have to pay for a TCS share is ₹3,182*.


The futures market functions on the futuristic or forecasted price of a stock. It involves a futures contract that dictates when the stock will be sold after reaching a certain value. 


The stock won’t change hands immediately. It will only be transferred on the maturity date. For example, a fund manager may buy a share for ₹1000 and sell it on the futures market at an agreed price of ₹1050. 


Arbitrage Opportunity #2: Different Stock Exchanges


Different stock markets offer arbitrage opportunities as well. The fund manager may buy a stock on the Madras stock exchange at ₹990 and sell it on the Bombay stock exchange for ₹1010.


The ₹20 price differential is the return that you’ll receive. Notice that the price differential is fairly low in each case so the fund manager has to trade multiple times to generate higher returns.


Arbitrage funds have a comparatively high expense ratio due to the heavy reliance on the fund manager. At the same time, they deliver moderate long term returns between 4 to 7%.


Speak to a wealth coach for more detailed information on arbitrage funds. Ready to invest? Download the Cube Wealth app today. 


Features Of An Arbitrage Fund


1. It is a hybrid or balanced fund 

2. Invests in both equity and debt (primarily in equity)

3. Simultaneously buys and sells stocks in different markets

4. Treated as an equity fund during taxation

5. Relies heavily on the fund manager’s intuitiveness

6. Returns earned are based on the price differential


Here’s why you should never pick mutual funds on your own


Benefits And Risks Of Arbitrage Funds

 

Benefits 

Risks

Low risk

Minimal arbitrage opportunities

Moderate returns

Uncertain returns

Taxed like equity funds

High expense ratio


Arbitrage Funds Vs Other Mutual Funds

 

Fund Type vs Average Returns

Arbitrage Funds

Large-cap Funds (Equity)

Banking and PSU Fund (Debt)

International Funds

3-year returns

4-6%

4-14%

4-11%

15-29%

5-year returns

5-6%

7-16%

6-8%

7-20%

10-year returns

6-7%

6-15%

4-9%

14-18%

Risk

Low

Moderately High

Low

High


Note: All facts & figures are as of 11-01-2021. Figures mentioned in the table above comprise publicly available data on Google. While we update our blogs regularly, check the Cube Wealth app for the latest facts & figures.


Top 2 Best Arbitrage Funds Of 2021 Currently Being Recommended On The Cube Wealth App

Cube’s mutual fund advisor, Wealth First, curates a list of the best arbitrage funds for Cube users every month. Here’s a snippet of the list of the best arbitrage funds:


  1. SBI Arbitrage Opportunities Fund
  2. IDFC Arbitrage Fund


Consult a Cube Wealth Coach to know if you should invest in the best arbitrage funds using the Cube Wealth app. Read this blog to know why investing using Cube Wealth is the right choice. 


Conclusion


Arbitrage funds invest in both equity and debt. An arbitrage fund relies on arbitrage opportunities that involve simultaneously buying and selling the same shares in different markets. 


An arbitrage fund is a hybrid fund that is treated as an equity fund during capital gains taxation. The high trade volume involved in an arbitrage fund may result in negative short term returns. 


Thus, liquid funds may be a better option for the short term compared to arbitrage funds. Read our comprehensive blog on the 10 best liquid funds for 2021. 


The Cube Wealth app gives you access to the best arbitrage funds with advice from Wealth First. Wealth First has a historical track record of beating the market by an average of ~50%. 


WF currently has an AUM of ₹7,000+ crores and advises over 3000+ clients. Cube’s very own leadership team relies on Wealth First’s advice. That’s right, we put our money where our mouth is.  


Download the Cube Wealth app or speak to a wealth coach today to get started.   

Watch this video to know the benefits of handpicked mutual funds on the Cube Wealth app


Shriram Shekhar
Shriram is a Consultant at CubeWealth. He has developed cutting edge IT products for over 2 years before turning to his passion for the written word. His love for philosophy, developing products, and empowering people through quality content is what got him to CubeWealth.

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