- Arbitrage funds have been attracting huge inflows of late, while debt funds are taking a beating
- The surge in interest for arbitrage funds, especially among HNI investors, is due to two factors: they’re low-risk compared to equity funds, and attract lower tax than debt funds
- The tax play is not just hurting debt funds, but also banks’ fixed deposits that have been suffering for some time now. Falling interest rates are not helping, either
- With a section of fund managers calling for equal tax treatment for non-equity funds, will the government level the field again?
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There’s a new star on the mutual-fund horizon that’s attracting huge inflows even as old favourites struggle.
Arbitrage funds, a type of hybrid fund that mostly generates returns by exploiting pricing mismatches across different exchanges and markets, are the darlings of this season. In April, these funds saw inflows of nearly Rs 11,790 crore—more than double the money they attracted in the preceding three months cumulatively, according to data from the Association of Mutual Funds in India (Amfi). In May, the inflows went up to Rs 15,000 crore.
Contrary to the hurrah in arbitrage funds, inflows into all equity categories put together dipped to Rs 19,000 crore in May from Rs 24,000 crore the previous month. Investors seem wary of high valuations, with the market again back to near-peak levels.
Debt funds—the ones that invest in fixed-income securities and other debt instruments—suffered even more. There was an outflow of nearly Rs 15,000 crore in May.
So why this huge inflow into arbitrage funds? One, they carry far lower risk compared to equity funds; two, the gains made off them attract lower taxes compared with debt funds, including liquid schemes. The best of both worlds, as things stand currently.
An arbitrage fund does what its name suggests—it makes use of the arbitrage opportunities in the market. For instance, if a stock trades at Rs 1,500 in the cash market and at Rs 1,520 in the futures market, the fund would make a profit by buying in the cash market and selling in the derivatives market. These funds could also capitalise on the pricing differences between stocks across exchanges, such as the NSE and the BSE.
Despite near-similar returns as liquid funds and banks’ fixed deposits, arbitrage funds have an edge over them. Thanks to tax changes in the 2023 and 2024 budgets, and a loophole.
Debt funds, which earlier enjoyed sweetheart tax treatment, lost their benefits, including
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