To earn post-tax returns similar to a debt or liquid fund and yet get the tax benefit of an equity fund, investors may consider arbitrage mutual funds.
Arbitrage fund is essentially an equity fund that aims for low volatility returns by using arbitrage and other derivative strategies in equity markets. The main objective of them is to generate income through arbitrage opportunities between cash and derivative market and arbitrage opportunities within the derivative segment and by deployment of surplus cash in debt securities and money market instruments.
Investments in them is predominantly in arbitrage opportunities in the cash and derivative segments of the equity markets and the arbitrage opportunities available within the derivative segment and by investing the balance in debt and money market instruments
The prices of stocks differ in the cash and the derivate market. This is the arbitrage or the price difference that such funds try to exploit. Illustratively, a stock may trade at Rs 100 in cash market and Rs 103 in the future market. Buying the stock in cash market while simultaneously selling it in the future market will lock in a profit of Rs 3 for the fund manager.
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