Arbitrage funds, considered low-risk investments, are funds that aim to generate potential returns by simultaneously buying and selling bonds in different markets. These funds may work by generating income through opportunities emerging out of differences in pricing between cash and derivatives markets. Arbitrage funds may take advantage of price differences and rely on those price differences between two markets.
Arbitrage Funds may be suitable for those investors who want to invest in low-risk investments and are looking for short-term to medium-term investments. It may also be an option for those investors who want to diversify their portfolios. These funds allow the investors to get potential returns from any slight price differentials in the market.
How do Arbitrage Funds work?
Arbitrage funds are funds that aim to generate potential returns by simultaneously buying and selling bonds in the market by exploiting price differences between derivatives and cash markets. These funds may thrive on market volatility as it may create more opportunities for price discrepancies. For example, an arbitrage fund investment may buy an asset in the cash market and sell it simultaneously in the future market at a higher price for potential higher returns. Here we can look at how these mutual funds work in the market:
- First, the arbitrage fund managers identify which assets or bonds can be bought and sold. The trading of the same at different prices in the spot market and the futures market is also identified.
- Then the bond or asset is purchased by the fund managers at a lower price in the spot or cash market.
- The aim of generating potentially stable returns is done by simultaneously selling the purchased bond or asset. The bond or asset is sold at a relatively higher price than what it was previously priced in future markets.
- Buying at a lower price and selling it at relatively higher prices in the futures market creates a risk-free position and locks in potential returns that are expected.
- Arbitrage funds investments continuously identify such opportunities across various bonds and derivatives allowing them to generate potential returns over time.
- These mutual funds aim to lower risk and may incur expenses related to trading costs, fund management fees and other operational expenses.
Strategies for Capitalizing on Market Trends
Arbitrage funds are considered low risk because they seek to take advantage of the price discrepancies rather than the market direction. The returns that are generated may be comparatively less volatile. Arbitrage funds can be a great option to capitalize. These are a few strategies that may be kept in mind:
- One must compare different markets before investing in simultaneously buying and selling of bonds and the returns generated by different arbitrage funds are important.
- These funds are usually for short-term investments. If an investor holds their shares for more than a year, the returns generated are taxed at a capital returns rate, which is lower than ordinary income tax. Therefore, they are taxed as equity funds since long equity represents an average of at least 65% of the portfolio.
- It might be important for investors to keep track of market conditions. Arbitrage funds cannot be considered very advantageous during stable markets. These funds may generate positive returns even when the market is volatile. Unpredictable payoffs may be kept in mind while investing in these funds for returns.
- Another important strategy is the cost investment when evaluating arbitrage funds. It includes the fund manager’s fee and also the fund management charges as these funds come with various costs including expense ratios, turnover ratios and transaction costs.
- These funds are a great option to earn reasonable returns for those who understand it and can make the most of it.
Conclusion
Arbitrage funds may be a relatively better choice for investment options for investors who are opting to invest in short-term investments, seeking a balance of returns. Investors should however carefully consider investment horizon, market conditions, tax implications, exit load, fund manager’s experience and fund size before getting into investment in mutual funds.
Disclaimer: Mutual fund investments are subject to market risks, read all scheme related documents carefully.
