Arbitrage mutual funds - Tax Efficient and Safe

Most mutual funds give you varied benefits depending on the lock-in period. Investors usually diversify to cut risk.

Jan 27, 2016 11:01 IST India Infoline News Service

Most mutual funds give you varied benefits depending on the lock-in period. Investors usually diversify to cut risk. In short, they do not keep all their eggs in one basket. If you seek to cut risk, while remaining uncompromising on tax efficiency, then arbitrage mutual funds could be an option worth considering, depending on where they fit into your scheme of things.

These funds have gained in popularity among investors over the years because of their taxation structure. Arbitrage mutual funds can be sold and bought on the BSE and NSE, thus enabling profit realization for investors. Arbitrageurs can trade in cash and derivative markets to gain profits that ensue from temporary gaps in markets. Notably, this involves minimal risks and thus is a good investment proposition.

Arbitrage mutual funds are treated on par with equity mutual funds, especially when it comes to taxation. If you hold these funds for a minimum period of a year, then the returns that accrue from them would be tax-free. The returns of these funds are usually in the range of 6-9% based on investment duration and yield of the product.

Why arbitrage funds are better over debt funds?
  • Investment in arbitrage schemes for at least 12 months involve no tax on capital gains and dividend, whereas debt funds are taxed at marginal rates if held for less than three years.
  • Arbitrage funds involve zero-risk; however, debt funds involve interest rate risks because the investment is usually into fixed income securities. Debt funds are considered as short-term, assets and hence, they involve a high level of risk.
  • Fund managers usually try to hold more than 65% to make arbitrage funds work as equity funds.
Facts to consider
  • Arbitrage and Arbitrage Plus funds are different. In arbitrage funds, the equity component is hedged completely by the investor, whereas in an Arbitrage Plus fund, investor has un-hedged positions to play with; nonetheless, this leaves the investor vulnerable to more risks than the former fund type.
  • These funds are tax efficient and generate risk-free income. Hence, high-income tax payers can invest in this fund.
  • Redemption of these funds can take around four days; so, if you need money the next day after redemption, then liquid funds would be a good option.
  • Another important thing which investors should know is that arbitrage funds have a small exit load ranging from 0.25% to 0.50%.

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