Artbitrage funds have a greater scope in 2009--

If you are interested in investing in equities but fear the market volatility, the smartest way will be to invest in arbitrage funds. These mutual funds are the best performing funds among the equity category in 2008. In fact, with uncertainty still haunting the financial market, these funds are expected to create value for investors in 2009. The higher the volatility, higher the arbitrage opportunity .But investors not familiar with this type of scheme might just end up thinking that these are just other equity-oriented schemes with a different name. However, this is not so and rather it is a type of income scheme. These funds take advantage of the arbitrage opportunities between the cash and the futures market to generate fixed income.

Such funds are better suited for investors who want low risk profile funds but expect decent returns. What leads (or rather misleads) everyone to believe that arbitrage funds are risk-free is that, in arbitrage strategies, both the buying and selling transactions exactly offset each other, thus making it immune to the market fluctuations. But uncertainty prevails in almost all investment schemes and these funds are no exception.The equity market in 2008 has given a lot of opportunities for arbitrage and mutual funds have been able to capitalize on that.

In India, a host of AMCs, including SBI, JM Financial, Kotak, UTI and IDFC, offer such funds. In the last 12 months, the average returns from arbitrage funds are around 8.8%. Scheme-wise, arbitrage funds such as UTI Spread Fund and HDFC Arbitrage Fund have given a return of 10.57% and 9.37%, respectively.

As far as tax treatment is concerned, since funds are largely invested in the equity arbitrage funds attract a short term capital gain tax of 15%. But if you hold it for more than a year, you are not liable to pay any tax. For tax purposes arbitrage funds are treated as equity funds. Hence, they enjoy lower tax vis-à-vis debt funds.

There is no denying that arbitrage funds are relatively less risky as compared to pure equities. However, to slot them as "risk-free", amounts to mis-representation. Arbitrage funds do have an element of risk; so investors who are being told that arbitrage funds are less risky have been misled.But all funds in this category have in the past one year or so outperformed their benchmarks by a convincing margin and there is greater scope for introducing these products in the coming days. Thus, the investor community should take to this concept more seriously.