Q.What is an arbitrage Fund ?

A. An arbitrage fund is one which uses equity market for debt like returns which gets tax benefit of an equity fund.

Q. Wow. How does it do this ?

A. It invests on an average 65%+ in cash future arbitrage, 20-25% in FDs for margin and 10% in Cash or Short Term Debt .

Q. What is cash future arbitrage?

A. The word arbitrage means taking advantage of price difference between 2 markets. Cash future arbitrage is one where you buy in Cash Market and Sell in Future’s Market.The difference is called arbitrage spread or your profit. You generally do it every month from one expiry to another expiry.

Q.This is very simple.Can we make lots of money ?

A. No.Since it is simple one cannot make lots of money as many people can & will do it. One can basically expect to make a short term fixed income like returns with better tax efficiency.

Q.So is it fair to say an Arbitrage Fund is in the nature of fixed income investment?

A.Yes for simplicity sake one can say that. It is also true if one really understands the nature of transaction cash-future trade is.By doing this trade you are providing funds, to somone who wants to take a long position in a stock in Futures Market , against the security of the same stock that you hold and earning the spread which is nothing but your interest on your capital deployed in cash market.

Q.I have captured the spread at the start of the cycle but can i loose money when i am trying to square off the cash future transaction?

A.The price in cash and futures market will converge on the date of expiry. Hence you are protected from market volatility. Once you have captured the spread you dont have to worry. At the end of expiry of the futures contract you can settle it against physical delivery. Or you can roll over the same for another month or you can square off both cash & future trade.So there are many options.

Q.Can returns be volatile? If yes what is the ideal investment horizon?

A.During the same cycle of one expiry to another expiry returns can be volatile as markets may move in all kinds of directions. But at the end of expiry both prices will converge and give you your pre assessed return.

Keeping the above in mind it is advisable to invest with a minimum of 3 months horizon or more. After 12 months it become even more tax efficient as LTCG sets in.

Q.What do i need to watch out for when i invest in any arbitrage fund?

A. You should look out for the following -Whether the fund is 100% hedged or not & Quality of fixed income exposure. Check for credit as well as duration risk.