Investors seeking stable returns with minimal risk often turn to fixed deposits (FDs) or debt mutual funds. However, in today’s evolving financial landscape, arbitrage funds present a compelling alternative. These funds offer the safety of debt instruments while providing tax efficiency and better post-tax returns, making them an attractive option for conservative investors.
Let’s explore how arbitrage funds work and why they can be a better choice than FDs or debt mutual funds.
Understanding Arbitrage Funds
Arbitrage funds capitalize on the price differences between stocks in the cash market and the futures market. Fund managers buy stocks in the cash market and simultaneously sell them in the futures market, locking in a risk-free profit. Since the buying and selling happen simultaneously, arbitrage funds carry low risk despite being categorized as equity funds.
Why Choose Arbitrage Funds Over Fixed Deposits or Debt Mutual Funds?
1. Better Tax Efficiency Than Fixed Deposits
Interest from fixed deposits is taxed on accrual as per the investor’s income slab, which can go as high as 30% for those in the highest tax bracket.
Income from debt mutual funds is taxed as per investor’s income slab when redeemed
Arbitrage funds, on the other hand, are treated as equity funds for taxation: Short-term capital gains (STCG) tax: 20% if redeemed within a year. Long-term capital gains (LTCG) tax: 12.5% on gains exceeding ₹1.25 lakh after one year.
For high-income earners, arbitrage funds provide better post-tax returns than FDs.
2. Lower Risk Than Equity and Better Returns Than Debt Mutual Funds
Debt mutual funds carry risks related to interest rates and credit defaults. If bond yields rise, the value of debt funds falls.
Arbitrage funds are free from credit risk, as they invest in equity markets through arbitrage trades. They typically offer returns comparable to liquid funds but with the added tax advantage.
3. Liquidity and Flexibility
Fixed deposits have a lock-in period and penalty on premature withdrawals.
Arbitrage funds provide liquidity with a T+2 settlement cycle, allowing withdrawals within one business day.
Debt funds are liquid with T+1 settlement cycle.
4. Suitable for Low-Risk Investors Amid Interest Rate Changes
RBI’s rate hikes impact fixed deposit rates—when rates are low, FD returns are unattractive.
Debt funds suffer losses when interest rates rise due to the inverse bond price relationship.
Arbitrage funds are not directly affected by interest rate movements, making them a stable choice in fluctuating economic conditions.
Conclusion
For conservative investors, arbitrage funds offer the perfect blend of stability, liquidity, and tax efficiency. While FDs provide certainty, they come with lower post-tax returns and withdrawal restrictions. Debt mutual funds, on the other hand, face credit and interest rate risks. Arbitrage funds serve as a superior alternative, offering market-linked returns with minimal risk.
If you seek higher tax-efficient returns than FDs and more stability than debt funds, it’s time to explore arbitrage funds as a smart investment option.
Happy investing!