The sharp outflow from the arbitrage funds may soon see a reversal with the equity markets turning volatile due to global developments including that of Covid outbreak and debt markets opening up fresh arbitrage opportunities.

Arbitrage funds are hybrid mutual funds that generate returns by using the strategy of simultaneously buying and selling of securities in different markets to take advantage of price difference.

Better returns

Arbitrage funds have captured a spread of 7-8 per cent in December, which is much better than liquid funds in the current scenario. This involves minimal risk since the equity exposure of arbitrage funds is completely hedged and unlike liquid funds, there is no credit risk in arbitrage funds.

Data suggests that most of the time spreads of arbitrage funds move in line with short-term interest rate fluctuations in the economy.

As interest rate moved higher, yield to maturity has jumped from 4 per cent to almost 6.5 per cent. This will also benefit arbitrage funds as fixed income investment accounts for 30 per cent of arbitrage funds.

Pressure on rollovers

Arbitrage funds have seen an outflow of ₹31,117 crore in the last six months with asset under management (AUM) plunging 23 per cent to ₹73,329 crore in November against ₹95,229 crore in June.

Being the self-correcting category, there is an inverse relation of AUM and returns in arbitrage space. With AUMs in arbitrage category shrinking and reduced pressure on short rollovers, the spreads have improved.

In the last few months, equity markets have improved significantly with markets touching new highs. In line with improved sentiment of equity market, arbitrage funds spread has also made a decent come back. Rollovers has happened around 70 basis points against average spread of 35-45 bps in the past few months, said Edelweiss Mutual Fund.

The long position (open interest) of high networth and retail investors had come down from the peak of ₹1-lakh crore to as low as ₹60,000 crore when markets fell sharp between April and May.

Investor sentiment bullish

With sharp recovery since June, long positions are again back to ₹85,000 crore. As investor sentiments turn bullish and participation increases, the long leverage positions in stock futures also go up increasing probability of higher returns, it added.

Arbitrage funds are treated as equity funds for taxation purposes, as these funds invest at least 65 per cent of their assets in equities.

Related Topics
comment COMMENT NOW