Mutual Funds: What Makes Arbitrage Funds a Hot Buy


Most investors expect market volatility due to lockdowns in various states, slowing demand and inflation in wholesale prices and the manufacturing PMI showing tensions.

With market volatility and concerns over the intense second wave of the pandemic and its possible impact on the economy, mutual fund investors are increasingly turning to hybrid plans. From January to April of this calendar year, hybrid plans reported net inflows of Rs 21,696 crore compared to a net outflow of Rs 29,203 crore from July to December 2020. In hybrid plans, investors opt for funds. arbitrage, balanced benefit funds, multi-asset funds and dynamic asset allocation funds versus pure equity funds.

In fact, equity-focused mutual funds saw a drop in net inflows to Rs 3,437 crore in April 2021, compared to a strong net inflow of Rs 9,115 crore the previous month. Prior to March 2021, the segment experienced net exits for eight consecutive months. Investments through systematic investment plans saw a drop in April to Rs 8,590 crore from Rs 9,182 crore in March, with investors preferring to stay on the sidelines until more clarity emerges around the impact of the second wave of the pandemic on the economy.

Hybrid category gains
In April, the hybrid fund category reported a net inflow of Rs 8,641 crore led by arbitrage funds at Rs 7,245 crore, followed by a balanced advantage fund at Rs 1,700 crore, balanced hybrid funds at Rs 184 crore and multi-asset allocation funds at Rs 26 crore. However, dynamic asset allocation funds reported net outflows of Rs 501 crore.

Hybrid funds offer different combinations of equity and debt investments and investors can select funds based on their risk appetite. By investing in hybrid funds, individual investors can create a balanced portfolio and earn regular income as well as long-term capital appreciation. For risk averse investors, hybrid funds are a better choice because they offer higher returns than debt funds and are not risky as an equity fund. So, in a situation where debt funds give lower returns and equity funds become risky, sophisticated investors place money in various hybrid class funds based on their risk appetite.

An equity-focused hybrid fund invests at least 65% of its total assets in equity-linked instruments and the remainder in debt-linked instruments. On the other hand, a hybrid debt-focused fund will invest at least 60% of its total assets in fixed income securities like bonds, debentures, government securities and the rest in stocks. However, balanced funds invest at least 65% of their total assets in equities and equity-related instruments and the remainder in debt securities.

Arbitration Fund
Most investors expect market volatility due to lockdowns in various states, slowing demand and inflation in wholesale prices and the manufacturing PMI showing tensions. Between January and April, the arbitrage funds reported net inflows of Rs 20,601 crore, the bulk of the total net inflows of Rs 21,696 crore received per hybrid category.

In arbitrage funds, the fund manager simultaneously buys stocks in the spot market and sells them in futures or derivatives markets and the difference between the cost price and the sale price is the return that investors earn . The price of a share in the derivatives market is marked up over its price in the spot market. This allows for an arbitrage opportunity that these funds attempt to cash in by buying a stock in the spot market and selling it in the futures market, thereby gaining the differential premium between the two prices.

While arbitrage funds benefit from the price difference between the spot and futures market and the spread increased to 70 basis points in April, individuals are investing aggressively in these funds now. Additionally, many of them scale their equity investments using arbitrage funds, as they offer higher after-tax returns than liquid funds. Arbitrage funds can provide reasonable returns to investors who can understand it and get the most out of it.

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