By Team Nevesh
Zerodha Fund House has added an arbitrage fund to its mutual fund lineup, giving investors another option for deploying surplus money without taking the full ups and downs of a conventional equity fund.
The Zerodha Arbitrage Fund is an open-ended equity scheme that will look for price differences between the cash and futures markets. The minimum investment is ₹5,000.
Unlike a regular equity fund, the scheme does not depend on a stock simply going up for it to make money. The fund will try to capture temporary gaps between the price of a stock in the cash market and its corresponding futures contract.
For example, if a share is available at ₹1,000 in the cash market while its futures contract is trading at ₹1,020, the fund can buy the share and sell the futures contract. If the two prices converge as expected, the difference can translate into a return after costs.
That is the basic idea behind arbitrage investing. The opportunity comes from the price gap, not from guessing where the stock market will move next.
At least 65% will remain in equity and equity-related assets
The scheme will invest at least 65% of its portfolio in equity and equity-related instruments, including derivatives, in line with the structure of an equity-oriented arbitrage fund.
When attractive arbitrage opportunities are not available, the fund can deploy part of its portfolio into short-term debt instruments, according to its investment strategy.
That gives the fund manager some flexibility when the spread between cash and futures prices is not wide enough to make a trade worthwhile.
But arbitrage does not mean risk-free.
The returns available to the fund depend on how many opportunities the market offers, the size of those price gaps, transaction costs and the performance of the debt investments used when arbitrage opportunities are limited.
Why investors look at arbitrage funds
Arbitrage funds occupy an unusual place in the mutual fund market.
They are classified as equity funds because of their equity exposure, but their strategy is very different from that of a typical large-cap, flexi-cap or mid-cap fund.
A conventional equity fund generally makes money when the securities it owns appreciate. An arbitrage fund attempts to lock in price differences between related positions.
That can make its returns less dependent on the overall direction of the stock market.
For investors with surplus cash and a relatively short investment horizon, this can make arbitrage funds worth considering alongside other short-duration options. But lower volatility should not be confused with a guaranteed return.
The opportunity set can change quickly. When cash-futures spreads are narrow, there may simply be less for an arbitrage fund to capture.
The ₹5,000 entry point
The new fund’s minimum investment of ₹5,000 keeps the initial ticket size low.
That does not, by itself, make the fund suitable for every investor. The more relevant questions are how long the money can remain invested, what returns the investor expects and how the fund compares with alternatives after taxes, costs and exit-load considerations.
Arbitrage funds are often considered by investors looking for a place to park money for a limited period while remaining within the equity-oriented mutual fund category.
The strategy can work differently from a bank deposit or a conventional debt fund, so investors need to understand what is actually generating the return before choosing it.
How arbitrage funds are taxed
The equity-oriented structure also matters from a tax perspective.
Arbitrage funds that meet the applicable equity-oriented criteria are generally taxed under the equity mutual fund capital gains framework.
For units sold within 12 months, short-term capital gains are taxed at 20%. Gains on units held for more than 12 months are treated as long-term capital gains, with gains above ₹1.25 lakh in a financial year taxed at 12.5%, subject to the prevailing tax rules.Mint
That tax treatment can make arbitrage funds relevant for investors comparing them with other ways of parking short-term surplus, particularly those in higher tax brackets.
But taxation should not be the sole reason for choosing the fund. Investment horizon, liquidity, exit load, expenses and the fund’s ability to find profitable arbitrage opportunities all affect the final outcome.
Zerodha expands its fund offering
The launch adds another category to Zerodha Fund House’s growing mutual fund business.
The fund house is a joint venture between Zerodha and smallcase and currently offers products including index funds, ETFs and fund-of-funds across different asset classes. It says its products are used by more than 12.5 lakh investors.
The arbitrage fund also fits with the broader shift in India’s mutual fund market, where investors have access to increasingly specialised products for different cash-management and portfolio needs.
For investors, however, the label matters less than the strategy.
An arbitrage fund is not a substitute for an equity fund simply because it carries an equity classification. Its return depends on the spreads available between markets and the manager’s ability to execute those trades efficiently.
The ₹5,000 minimum may make the fund easy to access. Whether it deserves a place in an investor’s portfolio is a separate question.MoneyControl
Risk Disclaimer: This article is for informational purposes only and should not be considered investment, tax or financial advice. Mutual fund investments are subject to market risks. Investors should read the scheme-related documents carefully and assess their investment horizon, risk profile and financial needs before investing.