Weekly Musings – NFO Pick (Bajaj Finserv Arbitrage Fund)

4 Sep 2023 , 06:39 AM

In the latest weekly coverage on mutual fund NFOs, we cover the Bajaj Finserv Arbitrage Fund. Today, arbitrage funds offer a lot of value to investors due to two reasons. Firstly, the market volatility has boosted returns on arbitrage funds as is evident from the returns on arbitrage funds in the last one year. Secondly, the arbitrage funds actually create a riskless arbitrage between spot equity and equity futures. This spread between the spot market and futures market is roughly reflective of the cost of funds or the interest cost. That makes it a quasi-debt product. At the same time, since equities account for more than 65% of its portfolio, it will be classified as an equity fund. That would make it more economical from a tax management stand point. Let us first look at how the arbitrage fund will work in the case of the Bajaj Finserv Arbitrage Fund.

How the Bajaj Finserv Arbitrage Fund will work in practice?

To understand the working of an arbitrage fund, we can take a simple example of the spot and futures price of a stock, say Reliance Industries. The Reliance spot price closed at Rs2,411.40 while the futures price closed at Rs2,428. Now Reliance Futures has a market lot of minimum 250 shares so for every 250 shares of Reliance Industries purchased, the arbitrage fund will sell 1 lot of Reliance futures. The position of being long on cash and short on futures of the same stock for the same quantity is an arbitrage position. In this case, the arbitrage profit per share will be Rs16.60. In percentage terms, this would be 0.69%. This may look like a small return, but we are talking about September futures i.e., for 26 days. When you annualize this you get a return of 9.5% to 9.6%, and the assumption here is that the arbitrage will be frequently churned by the trader, resulting in around 9.5% per year.

Remember, the 9.5% return may look small when you compare with equity funds, but you must compare with debt funds since this is almost a zero-risk position. When you are long on spot and short on futures, your risk is close to nothing since spot and futures expire at the same price on the expiry day. So, the arbitrage profit is yours for free. However, in reality, there will be brokerage and statutory charges, so the actual yield will not be 9.5% but lower than that. However, more interesting is the taxation aspect. Today, debt funds are either taxed at peak rate if debt holdings are less than 30% and at 20% LTCG with indexation if held for more than 3 years in case debt holdings are between 30% and 65%. In the case of arbitrage funds, it is classified as an equity fund, although mirrors debt funds in terms of safety and stability of returns. As an equity fund, the investor can pay concessional STCG of just 15% a concessional LTCG of just 10% after considering a basic exemption of Rs1 lakh for equity capital gains. It is like a double benefit for arbitrage fund holders. You get the stability of debt funds with the tax treatment of an equity fund.

How are arbitrage profits realized?

That is something that intrigues many investors. It is great that you create an arbitrage profit and lock in the assured returns. But, how do you realize these profits? Broadly, there are 4 ways to realize the profits on an arbitrage position for an arbitrage fund like Bajaj Finserv Arbitrage Fund.

1. The cash position can be held and the short futures can be short rolled each month at a premium. The short roll premium normally depicts the arbitrage returns on a monthly basis. This is the most popular method.

    

2. The second way is to close both legs in shorter time. For example, you created arbitrage at 0.69%, but the spread fell to 0.20% in 5 days. You can reverse the position and take away 0.49% (net of costs) in just 5 days. Such opportunities are rare.

    

3. The third method is to close aggressive on reversal. For example, you may have created an arbitrage position at 0.69%. But due to heavy selling in the cash market, the arbitrage spread may have gone into negative at -0.40%. In this case, you can book 1.39% in the month, but such windfall profits are again quite rare.

    

4. Finally, there is the VWAP closure. This happens on expiry day. The cash market position is sold in VWAP mode in the last hour and the futures position is left to expiry. This can be risky at times if the volatility spikes in the last few minutes.

Traders and fund managers deploy any of these methods to cash their arbitrage positions and realize profits. However, the first method of rolling over the futures short positions is the most popular.

Who should invest in the Bajaj Finserv Arbitrage Fund NFO

Bajaj Finserv Arbitrage Fund NFO is open for subscription to all eligible mutual fund investors who have completed their KYC and other formalities. However, from an advisory perspective, here is what you need to know.

• Arbitrage funds are extremely popular among HNIs. They get debt like stable returns but the tax treatment of equities. Hence, the arbitrage fund product is the most popular among the HNI investors. Most retail investors tend to gravitate towards equity products and most don’t understand the arbitrage product too clearly.

   

• Even corporates and some institutions prefer to park temporary surpluses in arbitrage funds due to the hedged position in the market. in the case of corporates, the decision is more opportunistic a they would look at arbitrage funds only if the returns are meaningfully higher than the debt funds. However, tax treatment is a major consideration for investors.

   

• Arbitrage is a workable game only if played conservatively. There are often opportunities for arbitrage fund managers to chase returns. However, many of these strategies can be very aggressive and also too risky. Investors must always satisfy themselves with the consistent returns of the fund on a rolling basis before investing in them.

   

• Last, but not the least, the Bajaj Finserv Arbitrage Fund must fit into your overall financial plan. It should not negatively impact the asset allocation of the investor or impact the journey towards the goals in any way. It is a debt fund and must be seen within that classification for asset allocation purposes.

With the backdrop of the above 4 points, investors can look to participate in the Bajaj Finserv Arbitrage Fund NFO.

Key highlights of the Bajaj Finserv Arbitrage Fund NFO

The Bajaj Finserv Arbitrage Fund NFO is an equity fund with a spread of the portfolio across large caps, mid-caps, and small caps. Here are the highlights of the NFO.

• The Bajaj Finserv Arbitrage Fund NFO opened for subscription on September 08, 2023 and will close for subscription on September 13, 2023, both days inclusive. It is an open ended fund, with low risk and offering continuing purchase and redemption at NAV-linked prices.

   

• The Bajaj Finserv Arbitrage Fund NFO offers a treasury product for short term parking of funds. As per the SEBI Risk-O-Meter, this fund is ranked as a low-risk fund due to its hedged nature and the absence of any unhedged positions in the market.

   

• The primary objective of the Bajaj Finserv Arbitrage Fund will be to generate higher returns in a safe and stable manner by arbitraging between spot and futures in equities. Returns cannot be assured on the fund.

   

• The Bajaj Finserv Arbitrage Fund performance will be benchmarked to the NIFTY 50 Arbitrage TRI (total returns index). As per SEBI regulations, mutual funds are required to benchmark performance with the TRI, which is the returns including dividends paid. 

   

• There are no entry loads in India as per SEBI regulations. However, there will be an exit load of 0.25% of the NAV value, if funds are redeemed or switched out within 15 days from the date of allotment of units.

   

• NFO subscriptions in the Bajaj Finserv Arbitrage Fund can be made in minimum parcels of Rs500 (SIP and lumpsum) and in multiples of Rs1 thereafter. The Bajaj Finserv Arbitrage Fund offers regular plans and direct plans. In addition, it only offers the Growth Option and does not offer the IDCW option.

The fund managers for the Bajaj Finserv Arbitrage Fund will be Nimesh Chandan and Siddharth Chaudhary. Both have extensive background in the mutual fund industry.

Understanding the Arbitrage Funds universe in India

The table below captures the universe of arbitrage funds in India. These arbitrage funds tend to be cyclical due to their dependence on market volatility but the tax advantage over debt funds should now work to its advantage.

Scheme Name	NAV Direct	1-Year Yield (%) Direct Plan	3-Year Yield (%) Direct Plan	5-Year Yield (%) Direct Plan	Daily AUM (₹ in Crore)
Invesco India Arbitrage Fund	29.94	7.81	5.63	5.84	6,982.79
SBI Arbitrage Fund	31.29	7.69	5.44	5.57	18,140.06
Kotak Equity Arbitrage Fund	34.71	7.56	5.55	5.82	25,972.08
Edelweiss Arbitrage Fund	18.05	7.50	5.53	5.92	6,710.31
Bandhan Arbitrage Fund	30.50	7.44	5.32	5.68	3,931.22
Nippon India Arbitrage Fund	24.96	7.44	5.45	5.86	10,408.11
Tata Arbitrage Fund	13.10	7.43	5.47		7,150.02
DSP Arbitrage Fund	13.62	7.42	5.16	5.58	2,212.47
ICICI Prudential Arbitrage	32.00	7.37	5.33	5.66	12,576.36
ABSL Arbitrage Fund	24.85	7.33	5.36	5.72	5,422.24
Mirae Asset Arbitrage Fund	11.74	7.30	5.30		381.04
HDFC Arbitrage Fund	17.55	7.28	5.23	5.42	6,557.90
Baroda BNP Arbitrage Fund	14.75	7.27	5.23	5.66	338.22
UTI Arbitrage Fund	32.41	7.26	5.30	5.69	3,144.52
HSBC Arbitrage Fund	17.70	7.23	5.24	5.68	1,701.79
Axis Arbitrage Fund	17.65	7.14	5.41	5.76	2,803.69
Union Arbitrage Fund	12.66	7.09	4.95		99.98
LIC MF Arbitrage Fund	12.63	7.08	5.05		19.64
Sundaram Arbitrage Fund	13.31	6.98	4.91	3.53	91.04
JM Arbitrage Fund	30.42	6.93	4.58	4.71	119.22
PGIM India Arbitrage Fund	17.14	6.90	5.11	5.34	160.08
NJ Arbitrage Fund	10.74	6.89			339.54
Mahindra Manulife Arbitrage	11.40	6.16	4.49		23.31
Bank of India Arbitrage Fund	12.64	6.13	3.96	4.57	14.56
ITI Arbitrage Fund	11.77	5.94	4.09		9.49
Groww Arbitrage Fund	16.26	5.52	3.82	4.53	2.47

Data Source: AMFI

There are about 25 arbitrage funds available in India today with total AUM of Rs1,15,312 crore. As can be seen in the above table, the 1 year returns are attractive and that is due to the enhanced volatility in the market. However, if you look at the arbitrage funds over 3 years to 5 years, then the returns are sub-6%. Hence arbitrage funds would chip in as a good alternative when the market volatility is supportive of higher returns on arbitrage funds. Investors must keep that in mind why applying for the Bajaj Finserv Arbitrage Fund NFO.