HIGHER-INCOME INDIVIDUALS GET MAXIMUM BENEFIT: Attractive spread drives arbitrage funds

financialexpress.com:

Investors are increasingly preferring arbitrage funds over liquid and ultra-short-term funds for parking their short-term capital to capitalise on the price differentials between cash and derivative markets. The tax structure is also making these funds attractive for individuals in the highest tax bracket.

On a pre-tax basis, arbitrage funds have delivered an average return of 7.1% in the last one year, outperforming liquid funds (6.7%). While the differences might seem modest on a pre-tax basis, the post-tax differentials are substantial, nearing 200 basis points, enhancing the attractiveness of arbitrage funds as an investment option.

The fund manager simultaneously buys shares in the cash market and sells them in futures or derivatives markets and the difference in the cost price and selling price is the return that the investors earns. Arbitrage funds are treated as equity funds wherein the investor can avail long term capital gains taxation rate of 10% if the fund is held for one year or more, while short term capital gains are taxed at 15%.

In contrast, debt fund investments made after March 31, 2023 are taxed at the slab rate irrespective of the holding period. In fact, arbitrage funds have witnessed substantial net inflows of `49,000 crore since April of this year, accounting for 68% of the total net inflows in hybrid funds.

Feroze Azeez, deputy CEO, Anand Rathi Wealth, says past returns of arbitrage funds have been high and the roll-over premium is still elevated and greater than liquid funds yields. “The returns for December are expected at 7.5-8% looking at the cost of carry in stock futures. The outlook is attractive till the arbitrage fund’s open interest in stock futures is lower than 40% of the total open