Arbitrage Funds are a special type of mutual fund that is mainly designed to capitalize on price inefficiencies that may exist between the related markets. The main objective of such a fund is to offer the investors with those returns which are relatively insulated from the market. This type of fund exploits price discrepancies between various markets to generate returns. The discrepancies that arise are mainly because of the differences in the prices of securities in the cash market and future or derivatives market. The main strategy of this type of mutual fund is to buy securities in one market and sell those securities in another market simultaneously to earn a profit.
Key Features of Arbitrage Funds
Some of the main features of arbitrage funds include the following:
- Dual market strategy: This type of mutual fund is mainly operated by exploiting the price differences that exist between the spot or cash market and the derivatives market. In this type of fund, the investors can buy the securities in the spot market and can sell the equivalent securities in the derivatives market.
- Low Market Risk: This type of fund is less affected by market fluctuation. The main aim of this type of fund is to maximize the impact of market movement on their returns.
- Capital Preservation: This type of fund provides moderate returns and mainly focuses on preserving the capital. As compared to other equity-oriented funds this type of funds are safe.
- Tax efficiency: This type of fund is tax efficient since they are classified as equity funds for various tax purposes. As compared to the traditional fixed income investments this type of fund provides certain tax benefits.
Advantages of Arbitrage Funds
Some of the advantages of arbitrage funds include the following:
- Reduced volatility: This type of fund has a stable investment option and with a market-neutral approach, it helps in reducing the volatility of returns.
- Consistent returns: This type of fund provides a steady return by capitalizing on the price discrepancies. Compared to the high-risk investment plan this type of fund provides a lower return but it will give you a steady return.
- Lower Correlation with Equity Market: This type of fund also has a lower correlation with the broader equity market. Thus this type of mutual fund is a very useful tool for diversification in a portfolio.
Thus arbitrage fund is a type of mutual fund that provides a unique investment avenue to the investors by leveraging market inefficiencies to deliver returns. But before investing in this type of fund the investor should understand the strategy of the fund completely and consider the potential complexity and associated costs. This will help them in achieving their financial goals.