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Thanks for this initiative. Need to get clarification on certain doubts. I need to know the investment strategy of Arbitrage Funds i.e. where they invest & how it generates profit.

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Basis the queries raised-

The Arbitrage Funds are a type of Mutual Fund scheme that are appealing to investors who want to profit from volatile markets without taking on too much risk. Arbitrage Funds invest in shares and futures of the same shares to gain from the price differential between the cash and futures markets. Rather than purchasing stocks and then selling them later after the price has gone up, the Arbitrage Funds purchase stocks in the cash market and simultaneously sell that interest in the futures market.  With two well-timed trades, the fund generates a profit.  Each security is bought and sold simultaneously; there is virtually no risk involved with longer-term investments. Though Arbitrage Funds are technically balanced or considered Hybrid Funds because they invest in both debt and equity, they are taxed as equity funds since equity represents at least 65% of the portfolio. For the purpose of taxation and classification, Arbitrage Funds are considered to be equity-oriented hybrid funds. Apart from the equity portion of the portfolio, Arbitrage Funds also invest in a range of debt and money-market instruments including cash.

Example: An Arbitrage Fund purchases 100 shares of a XYZ Company for Rs.120/- per share in the beginning of April and simultaneously sells 100 April futures contracts of XYZ Company for Rs.140. Subsequent to this transaction, 2 possible events may occur - either the price of company shares may go up by the end of April or may come down by the end of April.

If the price of XYZ Company shares goes up:-

Stock price at expiry = Rs.150
Profit/Loss of the Spot Transaction (stock market trade) = (150-120) x 100 = Rs.3000 (profit)
Profit/Loss of the Futures Transaction (derivatives market trade) = (150-140) x 100 = (-) Rs.1000 (loss)
Net Profit from both the transactions for the Arbitrage Fund  = 3000 - 1000 = Rs.2000.

If the price of XYZ Company shares goes down:-

Stock price at expiry = Rs.80
Profit/Loss of the Spot Transaction (stock market trade) = (80-120) x 100 = (-) Rs.4000 (loss)
Profit/Loss of the Futures Transaction (derivatives market trade) = (140-80) x 100 = Rs.6000 (profit)
Net Profit from both the transaction for the Arbitrage Funds = 6000 – 4000 = Rs.2000.

As shown in the example above, the Arbitrage Fund makes a profit no matter which way the market moves. In reality, however, the difference in prices of the futures contract and the spot transaction may be a lot less, therefore on an average Arbitrage Funds carry out multiple of these types of transactions in a day.

Arbitrage Funds perform best during periods of market volatility when there is a marked difference between the spot price and the futures contract price of equities. On the other hand when the equity market is less volatile, arbitrage funds may easily be outperformed by many equally low risk debt mutual funds. However, arbitrage funds do have one key advantage over debt funds - their Tax treatment. Arbitrage Funds are treated as equity for Tax purposes and are hence taxed at 15% if sold within one year of purchase. After 1 year, they are taxed at 10% (Post Rs.1 lakh capital gain exemption). On the other hand debt funds are taxed at slab rate (which could be as high as 30%) for gains within 3 years. They are taxed at 20% with indexation thereafter.

 

We request you to consult your Tax Consultant/Advisor for more details.

Disclaimer:

Risk Factors: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Please visit - www.QuantumMF.com to read Scheme Specific Risk Factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the scheme's objective will be achieved and the NAV of the scheme(s) may go up or down depending upon the factors and forces affecting securities markets. Investment in mutual fund units involves investment risks such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the Sponsor / AMC/ Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited (AMC). The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.