MILKING MARGINS

During market volatility, investors can benefit from arbitrage funds that capitalize on pricing disparities to generate returns

Risk appetite is an essential parameter that determines the asset class mix and investment choices for investors. Debt funds are a suitable option for individuals with a low-risk appetite, seeking steady and reasonably secure returns.

There is a type of fund that is not categorized as debt but exhibits the characteristics of a debt fund, such as relatively low risk and predominantly stable returns. These funds are commonly referred to as arbitrage funds

Arbitrage funds operate similarly to debt funds, offering relatively stable returns. These funds enjoy more favorable tax treatment compared to regular debt funds and are particularly suitable for short-term investments.

WHAT ARE ARBITRAGE FUNDS?

Arbitrage funds are funds that generate returns by capitalizing on the price disparity of a security between two markets. This disparity could be observed in the price of a security between two exchanges, such as the BSE and the NSE, or between two segments of the market, such as the cash market and the futures market.

Here, it is important to note that price disparities are short-term opportunities that can be advantageous to the fund manager if identified promptly and acted upon swiftly.

This approach to generating returns differs from the conventional style of investing, where an asset or security is bought with the objective of appreciation and/or providing regular returns in the form of a coupon. In an arbitrage fund, the fund manager will only invest if there is a price disparity and an opportunity to earn returns. Hence, there is no exposure risk to equities as the fund manager buys in one market and sells simultaneously in another.

The opportunities for investment are influenced by volatility, and empirical evidence suggests that higher volatility in equity markets tends to offer greater arbitrage opportunities.