TINESH BHASIN Arbitrage funds more stable than debt schemes

The volatility in debt funds can scare any retail investor. Though many believe debt funds are stable, things could go wrong when the bond markets become volatile. Like last week, when the 10-year G-Sec (government security) yield touched eight per cent for a while.

In such times, arbitrage funds could be a good option. These funds have been stable with consistent return, while medium to long-term debt funds witnessed periods of negative return. In the past year, the average return from arbitrage funds has been 6.24 per cent. The one-year return in the short-term debt funds category is 4.83 per cent, for credit opportunities funds at 5.43 per cent, income funds at 2.33 per cent and the dynamic bond fund category at 0.86 per cent.

Arbitrage funds are equityoriented and carry a low level of risk. These take advantage of the price difference between the cash and futures markets. Fund managers buy a stock in the cash segment and simultaneously sell its one-month futures contract. Thereby, locking in the spread at the beginning of the month. Hence, market volatility does not affect return; they hedge their entire equity exposure. So, an investor is unlikely to experience a downside.

These funds are best for low-risk investors, as they offer steady return and carry zero risk of capital losses. These are the best bet for investors looking at shortterm investments, below 18 months,” says Tarun Birani, founder and chief executive officer, TBNG Capital Advisors.

In a low interest rate environment, these are a better alternative to bank fixed deposits (FDs), especially for investors in the 30 per cent tax bracket. The fund category has been consistently delivering between six and seven per cent, year-on-year. What makes these attractive for investors in the highest tax bracket is the tax treatment.

If an individual redeems a debt fund within three years of investment, the returns are clubbed with his income. As arbitrage funds invest in equities, they are taxed like an equity-oriented fund. If an individual redeems after one year, there could be short-term capital gains tax of 10 per cent. However, if capital gains from all equity investment are below ~100,000 in a financial year, there will be no tax. If an investor redeems before a

year, he will need to pay short-term capital gains tax of 15 per cent.

The best performing fund category – liquid funds – has an average return of 6.81 per cent. If an individual withdraws money from these funds before three years of his investments, his posttax returns are 4.77 per cent if he is in the 30 per cent tax bracket and 5.45 per cent if he is in the 20 per cent bracket. Even if these investors had to pay long-term capital gains tax, the post-tax returns from arbitrage funds would work out to be 5.62 per cent, if you consider the category returns.

If an investor's investment horizon is over two years, look at options. “For investment horizons between two and four years, invest in a mix of ultra-short-term, shortterm and medium-term funds. As the yields are attractive and most of these follow an accrual strategy, investors can make up to eight per cent annual return,” says Vidya Bala, head of mutual fund research at FundsIndia. For a longer horizon than three years, investors should look at monthly income plan. These have potential to deliver up to 10 per cent annual return.