Arbitrage Funds: How They Work and Who Should Invest
Arbitrage funds are a kind of mutual fund that aims to obtain gains through price differences in different markets. It means that a security is purchased at one market and sold at another at different prices. This mostly takes place between cash and derivative markets. These funds are low risk because they focus on price movements over the short term. Investors who need a stable return with low risk may find arbitrage funds useful. This article explains arbitrage funds, their workings, and who should invest in them.
What are Arbitrage Funds?
Arbitrage funds are a type of hybrid mutual fund that tends to generate capital gains by using price differences in the markets. It focuses on buying and selling securities in two different markets at different prices. For instance, if a fund manager buys a stock at a lower price in one market and sells that same stock at a higher price in another market, the difference between the two prices is the gain for the fund manager. This strategy is known as arbitrage.
Arbitrage funds are invested in equities, stocks, and debt instruments, such as bonds or short-term securities. The aim is to earn steady returns.
How Do Arbitrage Funds Work?
Arbitrage fund operates on the concept of taking advantage of market price differences. Such differences may arise in two major ways:
Between Exchanges: A share can be traded at a different price on different exchanges. In this case, the fund manager buys at a lower price and sells at a higher price.
Between the Spot and Futures Markets: A stock can be priced higher in the cash (spot) market than in the futures market. The fund manager can buy the stock on the spot market and sell it in the futures market at a higher price.
The fund manager looks for the price differences and buys and sells stocks simultaneously, they make gains without taking much risk. This process is repeated as new arbitrage opportunities arise.
Who Should Invest in Arbitrage Funds?
Arbitrage funds may tend to be suitable for the following types of investors:
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Risk-Averse Investor: Arbitrage funds can be useful for risk-averse investors looking for low-risk investment opportunities.
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Short- to Medium-term Investors: If a stable return over a short or medium-term horizon is needed, then arbitrage funds may help.
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Portfolio Balancing: Arbitrage funds play an important role in balancing a portfolio, especially for investors who prefer low-risk assets like fixed deposits, liquid funds, or debt instruments.
Conclusion
Arbitrage funds provide a low-risk investment option with steady returns. Fund houses like Axis MF offer arbitrage funds that aim to gain from the price differences in the market. While they carry less risk than regular equity funds, the returns may also be moderate. Before investing, it's important to check the expense ratio, past performance, and tax benefits. If you're looking for a balanced, low-risk option, arbitrage funds can be a good choice.
