Equity mutual fund investors are generally advised that they should wait and be patient after investing money in any fund and they should only sell it when the valuation of your investment has increased enough to give you good returns. However, there is one equity investment in which fund managers invest only when they see a sure-shot chance of profit-making. These funds work in a totally different manner compared to other funds and are known as Arbitrage Mutual Funds. Because it follows a totally different investment strategy, this is said to be the least risky way to invest in equities.
In terms of equity investment, "Arbitrage" means buying and selling a share in two different exchanges at different prices and making a profit due to this price difference in the two exchanges at any given point in time. For example, if a share is priced at a higher value in exchange 'A' but at a lower value in another exchange 'B', then one can buy it at the lower value in B and sell it making a profit in A. Similarly one can book profit due to a share's price difference in spot markets and future markets.
Still, there are two challenges in booking profit via Arbitrage Mutual Funds. Firstly, you need lots of time on your hands and an uncanny talent to spot the price difference in multiple stock exchanges and look for the perfect opportunity to get a chance to 'Arbitrage'. And secondly, the difference in price of a share in two exchanges is generally not big enough. So in order to book substantial profit, you need to up the volume of these deals. It is not easy for an average retail investor. But you can get the benefit of this strategy by investing in Arbitrage Mutual Funds. These fund managers and their teams are always on the lookout for an opportunity to 'Arbitrage' and book profit by buying and selling multiple times. Arbitrage fund managers only invest when they see an opportunity to book profit by buying and selling a share in different exchanges. This makes Arbitrage Mutual Funds less risky than other funds. When fund managers do not see any profit in this strategy, they keep the fund parked in short-term money markets or date instruments so that the investor gets some return.
Arbitrage Mutual Funds are actually Hybrid Mutual Funds which are categorised as Equity Mutual Funds for taxation purposes. This means if you remain invested in this fund for one year and only withdraw after holding it for that period then the profit up to Rs. 1 Lakh in that one financial year will be tax free. Long-Term Capital Gains (LTCG) tax is applicable for profit over Rs. 1 Lakh. If you withdraw that before one year then you will have to pay a 15 per cent Short-Term Capital Gains (STCG) tax.
Arbitrage Mutual Funds are considered less risky because the fund managers only invest when they see an opportunity to book profit. But these opportunities are few and far between and the price difference between the two exchanges is also not big hence the return you get on this is also average. In the last year, the country's top Arbitrage Mutual Funds have yielded an annual return of 8 per cent. The returns look even better if you add tax benefits to it but like every other investment one must remain cautious as no investment can guarantee what is in store for the future. Always consult an expert and analyse your investment needs. In the case of Arbitrage Mutual Funds, check their Total Expense Ratio and Exit Load before making any decision.