Pure arbitrage funds generated the highest post-tax returns and outperformed all other mutual fund categories between July 1 last year and June 30 this year.

A CRISIL Research analysis of mutual fund performance over the past 12 months revealed that pure arbitrage funds gave the highest post-tax returns outperforming other fund categories. The analysis is based on the performance of eight arbitrage funds.

From July 1, 2011, to June 30, 2012, arbitrage funds gave a post-tax return of 9 per cent compared with 8.4 per for debt funds and 4.1 per cent loss for equity funds. During the volatile 2006-2008 period, arbitrage funds had given post-tax returns of 8-9 per cent.

Arbitrage funds are a niche category which tries to take advantage of the equity price difference between the cash and futures markets. The ability of these funds, treated at par with other equity funds for tax treatment, to generate higher returns depends on the volatility in the equity markets — the higher the better. The troubled and volatile equity market over the past year has provided enough opportunity for such funds to generate higher returns.

Arbitrage funds have been in existence in the country for the past eight years. The erstwhile Benchmark Mutual Fund (now Goldman Sachs Mutual Fund) was the first mutual fund to launch an arbitrage fund. At present, there are 15 funds in India which use arbitrage strategies to generate returns.

However, CRISIL cautioned, due diligence before selecting an arbitrage fund is important. “Investors need to differentiate between pure arbitrage and arbitrage plus funds. In the former, the equity component is completely hedged while the latter can take unhedged positions and carry a higher risk. Only eight of the 15 domestic arbitrage funds can be considered as pure arbitrage funds”, it said.

It is also important to ensure that their arbitrage funds maintain an equity exposure of at least 65 per cent to enjoy the tax benefits of an equity fund. “While choosing arbitrage funds, one also needs to look at the exit loads that range from 0.25 per cent to 1 per cent for exits varying from seven days to one year,” CRISIL added.

(This article was published on July 18, 2012)
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