Arbitrage funds get their mojo back on HNI rush | Economic Times

This year, arbitrage funds are as much in favour as the fancied consumer-tech IPOs, with the spotlight firmly back on an investment category that had its fair share of sceptics through a roller-coaster 2020.From cumulative exits in the immediate aftermath of Covid, arbitrage funds now dominate the monthly mutual-fund leader-board, with subscriptions increasing steadily through January. In July, arbitrage funds saw inflows of ₹14,924 crore. This is the highest monthly tally for arbitrage funds in the past two and a half years - and about two-thirds of inflows into equity schemes in July.So, what's boosting the inflows?"High net worth individuals (HNIs) have been prompt enough to take advantage of the spread between the spot and futures markets. This is a key reason why flows into arbitrage funds have been increasing," said Bhavesh Jain, fund manager, Edelweiss AMC Arbitrage Fund. "Since the beginning of this calendar year, the spread has been increasing when compared to the average spread of the calendar year 2020."The spread is the difference between the prices of a company's shares trading in the cash and futures markets. The spread indicates the return an investor can make before tax.In 2020, the average spread for arbitrage funds was 35 basis points (bps). Year to date, thanks to increasing volatility, the spread increased in the range of 40-45 bps. In June-July, the spread peaked at 55 bps. One basis point is 0.01%."Most HNIs have an investment horizon of less than six months. They follow a clear and simple strategy. Investing in arbitrage funds is largely considered a viable alternative to liquid funds. In fact, most HNIs keep in mind the post-tax returns while investing in arbitrage funds," said a fund manager who didn't wish to be named.In the past three months, liquid funds have generated returns in the range of 3-3.5% while arbitrage funds have given returns in the range of 5-5.5%. This difference of 100-150 bps has served as a convincing reason for most HNIs to shift their investments to arbitrage funds. "Most HNIs shift investments to arbitrage funds clearly to take advantage of the tax treatment. Arbitrage funds are treated as equity funds," said Harshavardhan Roongta of Roongta Securities. "Hence, investments sold in these funds in less than a year attract 15% capital gain tax and over a year, attract 10% capital gain tax. In comparison, liquid funds attract the marginal tax rate slab (33% for HNIs and 25% for corporations)."To be sure, in the coming months, managers and distributors believe that flows may taper off in arbitrage funds."Already the Assets Under Management (AUM) of arbitrage funds is at a record high. In the coming months, there may be pressure on returns. This may weaken flows in arbitrage funds," said a fund manager. "For the July-August period, the spread has come down to 35 bps from 55 bps in July. I think once the difference between the returns of liquid and arbitrage funds narrows to 30 bps, one may see outflows in arbitrage funds."