Higher returns & change in taxation of debt funds attract investors

Arbitrage funds have attracted significant investments by large investors such as high net worth individuals (HNIs) and corporate investors in the past three months. Inflows into arbitrage funds have been primarily responsible for the surge in assets of equity funds in the last three months. From a contribution of less than 1% two years ago, arbitrage funds now contribute 7% to the total equity assets under management (AUM).

Factors such as better returns compared with the fixed-deposit returns, and change in shortterm tax treatment of debt funds have resulted in massive investments in arbitrage funds by these large investors. As a result, in the past three months, the AUM of arbitrage funds has grown by 92% to . 26,615 crore in ` June from . 13,885 crore in ` March. On the other hand, the other hand, the AUM of equity mutual funds industry grew by just 8.8% to ` . 3.32 lakh crore.

Arbitrage funds have provided returns of 8.5-9% annually .For a sustained inflow, returns should be 30-40 basis points higher than that of liquid funds

According to Value Research, Edelweiss has offered the best return of 8.7% in the arbitrage fund category . The AUM of arbitrage funds has expanded by ` . 12,729 crore in the past three months.The biggest gainer, in terms of AUM expansion, has been JM financial (inflow of ` . 2,730 crore), followed by ICICI Pru (. `2,104 crore), Kotak (.`1,783 crore), and Reliance (.`1,664 crore).

Arbitrage funds aim to generate returns by tracking the price difference of stocks which are available for trade in cash and futures markets. Suppose on July 1, a fund manager buys 1,000 shares of Reliance Industries in cash market, which are trading . 990 per share. Heshe then at ` sells an equivalent quantity in the futures market at ` . 1,000 a share. Thus, the fund manager earns a spread of `. 10 per share, or 1.1% per share. Given these facts, large investors keep a keen eye on these funds.

Another major reason for increase in investments in arbitrage funds is the change in the tax policies. During the July 2014 Union Budget, the government increased the period for which the short-term capital tax would be applicable on the returns of debt funds from one year to three years. As a result, large investors have been shifting their investments from debt funds to arbitrage funds.

Nearly half of the total inflows in June, we believe, origi nated due to tax factor. Apart from this, we are witnessing nearly ` . 5,000-6,000 crore of inflows every month into the regular equity schemes. T he AUM of the arbitrage fund of Birla fund has increased to . 699 crore in June 2015 as against ` . 143 crore three months ago.` Experts point out that the returns generated by arbitrage funds would not grow further and may come down in the coming months. The open interest of derivative stocks in the market has on an average reached . 52,000 crore. Arbitrage funds ` now account for over half of this compared with less than 5% two years ago. Given such a high concentration, incremental money that comes in the market will be chasing the same stocks. This would impact the returns of arbitrage funds as it would limit expansion in price differential between cash and futures market.