Mutual funds invest in shares, bonds, alternative assets, and other market securities. These funds allow you to invest through the lump sum or SIP (Systematic Investment Plan) mode, where you contribute a fixed sum in the mutual fund scheme at defined intervals for a specific period. Professional managers manage mutual funds per your financial goals, risk tolerance, and investment objective.
One type of mutual fund is the arbitrage fund. Arbitrage funds involve buying and selling securities in different markets and earning money from the price variations in security prices across these markets. These mutual funds are a good investment for investors who want profits without assuming high risk.
Here is everything you should know about arbitrage funds:
What are arbitrage funds?
Arbitrage funds are equity-oriented or hybrid mutual funds that leverage price differentials in different markets. Generally, these funds profit from the price variation between current and future securities to maximize returns. The professional fund manager buys shares in the cash market to sell them in the futures or derivatives market, which causes a difference in the purchase and sale price, resulting in returns at low risk. Even though the price difference is nominal, the trade volume helps make substantial gains through arbitrage funds.
How do arbitrage funds work?
Generally, the cash market price of a stock, also known as sport price, is considered the value of a particular stock. For instance, if X Ltd. sells its share for a cash price of Rs. 20, you can buy a single share of X Ltd. for Rs. 20. When you buy 200 shares of X Ltd., you invest Rs. 4000 in X Ltd. This is the cash market functioning.
However, the futures market works slightly differently than the cash market. A futures market is a derivatives market, and the contracts here are not defined according to the current share price. The future contracts reflect the projected worth of the underlying stock in the future. In the futures market, shares are transferred on the maturity date of the agreement for a pre-determined price.
Arbitrage funds take advantage of this mechanism between the cash and futures market. These funds buy stocks in the cash market and sell the same shares in the futures market for a higher price if the market is bullish on the shares. When the market is bearish, arbitrage funds purchase low-cost futures contracts and trade the same claims in the cash market for a higher price.
For instance, the 200 shares of X Ltd. might be selling at Rs. 20 today but in the next month, the prices will likely rise. In this case, a futures contract for the same shares with a maturity period of one month will be valued more. This difference in the price of shares between the cash and futures market is the arbitrage profit. Arbitrage funds can also make money from trading on different stock exchanges.
Overall, arbitrage funds are a good investment option for low-risk investors, especially in the situation of high and persistent market volatility. Arbitrage funds are safe investments that capitalize on the market inefficiencies and generate attractive returns. Moreover, these funds enjoy a similar tax status as equity mutual funds. You can use the Tata Capital Moneyfy app to find suitable arbitrage funds and also use the app to track the changing value of shares and capitalize on lucrative market opportunities.