What are arbitrage funds? When are these funds appropriate for you?

In the last couple of years, one category among the mutual funds has gained popularity – the arbitrage funds. It is important to understand what these funds are, how they work and what purpose these serve. One must also understand the risks involved in these funds. Click here to read my article published in Mid-day Gujarati edition.

___________________________________________________________________________________
The English translation of the article is as under:

What are arbitrage funds? When are these funds appropriate for you?

In the last couple of years, one category among the mutual funds has gained popularity – the arbitrage funds. It is important to understand what these funds are, how they work and what purpose these serve. One must also understand the risks involved in these funds.

We covered this category in our column on February 6, 2017 with proper example. However, we feel that there are a few misconceptions around this category that need to be clarified, especially looking at the amount of money getting parked in these funds. Many consider this as safe as liquid funds, with the benefit of lower (or zero) taxation.

Arbitrage is a strategy to generate returns due to the price difference between two different markets for the same (or similar) securities. This often happens between the cash segment and futures segment of the stock markets, on account of what is technically known as the “cost of carry”. This “cost of carry” is akin to interest charged for short term borrowing.

However, since the money is invested in stocks (at least 65% of the scheme’s corpus), the fund is treated as “equity oriented fund” according to the Income Tax Act. This means the dividend is tax exempt in the hands of the investor, as well as exempt from the dividend distribution tax. Capital gains are tax-exempt, if the holding period is more than one year. Even when the capital gains are booked for a holding period of less than a year, the same is taxed at a lower rate of 15% and not clubbed with the income.

This tax arbitrage is drawing a lot of money towards these funds. However, it is important to understand the investment before getting on to the discussion of taxation. The investment theory must precede considerations of tax and the investment theory would help one analyse the risk-reward trade-off.

First of all, let us make one point clear: as per the classification for purposes of income taxes, arbitrage funds may be classified as equity-oriented funds, but in terms of investment theory, these are alternatives of liquid funds. Hence, please do not expect returns in line with equity funds. These funds can generate investment returns very similar to those generated by liquid funds.

At the same time, while liquid funds invest in money markets and debt markets; arbitrage funds exploit arbitrage opportunities between two different segments within the equity markets.

Pure arbitrage is considered to be an almost zero risk strategy, since the prices converge on expiry of the futures contract. However, there is a possibility that the spreads widen before the contract expires. In such a case, there could be negative returns, temporarily. One must be aware of this.

Such short term negative returns may coincide with your parking horizon and thus, you may end up with very low or even negative returns, if you have parked money for very short periods of time. This only means that one should not treat arbitrage funds as a total replacement of liquid funds, but use these only when the time horizon is slightly long, say at least one month.

In spite of the risk highlighted, the arbitrage fund could be a good place to park your fund and enjoy the reduced taxation.

-       Amit Trivedi

Equity investments simplified - transcript of chat on www.moneycontrol.com

Questions on mutual funds - answered today at www.moneycontrol.com

Click here to read ...

Liquid mutual funds offer the facility to get instant access to your money

Many do not know this facility offered by certain mutual funds - instant access to your money. Though, it is is for a limited amount currently, it still remains to be a great facility. Click here to read further.
__________________________________________________________________________________
The English translation of the article is as under:

Many people keep large sums of money in current and savings accounts. They do it for a simple reason: what if the money is needed urgently?

Well, how urgent could be the need? And how much money may be required in such an emergency? It is in just a handful of exceptional cases that one has bothered to consider these two questions.

Most others operate out of fear. The fear is fully expressed in the earlier question about the urgent need. They support this argument further by stating that the emergency comes unannounced. It gives no time for any preparation. The argument is correct that there is no prior notice before an emergency. However, consider any situation – the emergency may come unannounced, but is there some time before money may be required? Even in case of hospitalization, how much money is required upfront? Will the hospital deny admission?

This is where one may consider some unconventional options to put the money to a better use. These options are the innovations in the financial markets that can be used to your advantage.

One such innovation is the liquid mutual funds that can be used for parking money for very short periods of time. One may also consider parking money for as short a period as three to four days. There is no limit on the maximum period for which such funds can be used. The beauty of these products is that there is no maturity period and the investor also need not specify for what period the investment is being made.

These funds have the potential to deliver more than what one gets from savings bank accounts or bank deposits of less than a year’s maturity.

Through a recent development, the regulator has allowed instant redemption facility from these liquid funds upto a maximum of Rs. 50,000 per account or 50% of the balance in the folio, whichever is lower. On redemption, the bank account would be credited within half an hour. This is a fantastic facility in case of emergency.

So go ahead and utilize this facility from the liquid funds.

- Amit Trivedi
The writer is the author of a book "Riding The Roller Coaster - Lessons from financial market cycles we repeatedly forget"

Whether in equity fund or debt fund - all can benefit from the disciplined investing through SIP

A lot has been written about the benefits of SIP in equity funds. However, little has been discussed about the same in the context of debt funds. Click on the link to understand how SIP in debt funds can be useful to you:

__________________________________________________________________________________
The English translation of the article is as under:

“My daughter is studying in the 10^th standard now. She would be ready for the college in a few years. I want to be financially ready to fund her education.” A proud father of a daughter was talking to his friends. Let us analyse the situation.

The daughter is going to college for higher education in just three years. There is a possibility that they have figured out what kind of course and college that she may attend. It does not matter whether the girl and the parents have decided on the course. Whether they have decided or not - whatever the case, there is a need to be financially ready. If one has not done anything so far, one needs to start investing as soon as possible.

However, in this situation, the goal is very close – just three years away and a serious one at that. Due to such a short time period, it would be unwise to take an exposure to equity. That means, one should avoid investing into equity mutual fund in such a case. At the same time, one has 36 months to accumulate the money. Such an investor should consider investing through SIP.

The option now for the investor is to consider doing a regular monthly investment in a fund that is not risky, i.e. one may consider a debt fund (especially short term debt fund or an ultra short term debt fund). Such funds invest in debt securities issued by various companies, banks and even government. since the investments are in debt securities, the funds are a lot safer than equity mutual funds.

Since most of the discussions on SIP end up talking about long term goals and SIP in equity funds, many are not aware that it is possible to fund near-term goals through SIP in fixed income funds, too. While discussing the benefits of SIP, majority of the experts highlight two benefits (1) Rupee cost averaging, and (2) Power of compounding. The former is derived due to the volatility inherent in equity, whereas the latter too is a function of the nature of equity to potentially provide high returns in the long run. As can be seen, both the major benefits talked about are related to equity. However, some of the underplayed benefits of SIP are as under:

·      SIP brings discipline to one’s savings approach

·      SIPs allow large sums to be accumulated even by saving small

·      It helps automate the savings approach

In the situation described earlier in this article, or any such similar situation, it is possible to accumulate the required amounts through SIP in debt funds.

Equity investments simplified - transcript of my chat on12th June 2017

Click on the link below to read the transcript of my chat on www.moneycontrol.com today

Equity investments simplified

Live chat on www.moneycontrol.com

Equity investments simplified
Pros and cons of investing through Equities

Join me on the live chat on www.moneycontrol.com today at 4 pm to get your questions regarding mutual funds answered

Equity investments simplified - chat transcript April 10, 2017

http://www.moneycontrol.com/news/mgmtinterviews/chats/detail_new.php?chatid=2849

Arbitrage funds - for short term parking of funds

Please click on the link here to read the article, published in Mid-day Gujarati, Mumbai edition on 6th February, 2017

_________________________________________________________________________________
The English translation is as under:

In the last few years, one of the mutual fund categories has become quite popular – especially among individual investors intending to park money for short periods of time. This category is known as “arbitrage funds”.

As such, the name does not indicate anything, especially for the uninitiated investors or someone who is less familiar. However, these funds are among the safer funds in that they do behave almost like liquid funds. As mentioned earlier, these funds may be considered for parking money for short periods like a month or a quarter or so.

Let us understand how these funds work.

The term arbitrage means “simultaneous buying and selling of same securities, commodities, or foreign exchange in different markets to profit from unequal prices.” Arbitrage requires two separate markets and a price difference in these markets for the same security. Since one is simultaneously buying the cheaper one and selling the costlier one, this is a profit-making opportunity without involving any risk.

In reality, there could be transaction costs involved in both buying as well as selling. These costs need to be adjusted before arriving at the profit number. Such anomalies do exist at times and many players take advantage of the same.

Lest us elaborate on this in the Indian context through the example of arbitrage opportunities in stock markets.

On 3^rd February, Axis Bank stock closed at Rs. 489.90 on the National Stock Exchange and at Rs. 489.65 on the Bombay Stock Exchange (both prices are taken from the cash market segment). If someone could buy on BSE and sell on NSE simultaneously at the closing price, there was a net profit of Rs. 0.25 per share, assuming the transaction costs to be zero. (For the purpose of this discussion and example, we would assume the transaction costs to be zero. For simplicity, we are also assuming that one has to deliver the shares at the NSE only after receiving the same from the BSE.)

Since both purchase and sale happened simultaneously, there is no risk involved – whatever happens to the price of the stock. The profit of Rs. 0.25 per share on a share price of Rs. 489.65 translates into a profit of 0.051% for a day, or 18.64% per year. Please understand that this calculation is based on the assumption that the transaction costs are zero. Once you adjust for the costs, there is no profit opportunity left.

On the other hand, there is generally a price difference between the cash market and the derivatives market. Taking the example of Axis Bank once again, on the BSE cash market segment, the closing price was Rs. 489.65 and that for Axis Bank futures (expiring on 23^rd February) was Rs. 491.30. This meant that the futures price is higher than the cash market price by Rs. 1.65 per share. Someone can profit from this opportunity (once again, this calculation is without factoring the transaction costs) by buying the shares in the cash market segment and selling the futures. The futures contract would automatically expire on 23^rd February, whereas the shares bought on cash market must be sold on the same day. That means, the investor would be investing Rs. 489.65 per share for 20 days and earn a profit of Rs. 1.65 for the same. This translates into an annual profit of 6.15%.

If during the 20 day period, share prices go up, one would profit on the cash market – the shares bought, whereas lose on the futures market – futures contracts sole. If the prices go down, it would be reverse, i.e. loss in the cash market segment and profit in the futures market. Thus, theoretically, one has pocketed the annualized profit of 6.15%, irrespective to what happens to the price thereafter. This is why such trade is considered risk-free.

Arbitrage funds take the advantage of such opportunities.

At the same time, as we have seen in the numbers, most of the time, the profit is in the range of the returns liquid funds can generate.

Since these funds invest in the stock market, such funds may get classified as equity funds for the purpose of income tax. That makes these funds very attractive as compared to liquid funds.

- Amit Trivedi

You enjoy your holidays and your money works for you, is it possible?

You enjoy your holidays and your money works for you, is it possible? Read my article on the subject in Mid-day Gujarati edition today. ________________________________________________________________________________ English translation is as under: How does it sound when your money works for you even when you are enjoying your holidays? August is the month of festivals and long weekends. Many of us go for mini-vacations – either on some excursions or to meet our families. During such periods, often the money lies idle in the bank accounts. There are no options where the money can be parked to earn some returns. Bank fixed deposits are available for a minimum period of 15 days if the amount is small. That means, the money remains idle in savings or current accounts. With most banks, the current accounts do not earn a single rupee and the interest on savings accounts is a low 4% p.a. In such cases, mutual funds offer an incredible opportunity in form of liquid funds. It is possible to invest amounts as small as Rs. 10,000 and even for weekends. Many large companies use this facility offered by mutual funds to park money for weekends. The liquid funds are open-ended mutual funds and hence the transaction can be done on any business day. Let us say, there is a holiday on a particular Monday, making it a long 3-day weekend – Saturday, Sunday and Monday. If you have surplus money in your bank account on Friday before these holidays, you can invest the same in a liquid fund and simultaneously file for redemption such that you get the money in your bank back on Monday. In case you do not need the money on Monday, you may continue to stay invested. Mutual funds offer a great flexibility in terms of not declaring the investment period in advance. You may invest your money in a liquid fund without mentioning the date of redemption in advance. You may stay invested till the time you do not need the money. As per the website of Value Research, a leading portal for mutual fund information, the liquid funds have delivered the following returns in the past: Table 1: Period Returns (p.a.) Last week 6.76% Last month 7.08% Last 3 months 7.36% Last year 7.83% (Disclaimer: Past performance may or may not be sustained in future) As you can see, the rates of return are around 7% p.a. However, you may also observe that the returns for the shorter periods are lower than the longer periods. This is not like a bank fixed deposits where they offer lower interest rates for shorter periods and higher for longer periods. This has happened in case of liquid funds since in the last some time, the interest rates have come down. Liquid fund is a product that responds to the changes in interest rates in the market very fast. If the interest rates in the economy start going down, the liquid fund returns would get adjusted and if the rates start going up, the liquid fund returns would improve. Let us do some Math with the above numbers. If you have a surplus of Rs. 5 lacs to be invested for a long weekend (3 days), how much do you earn? Table 2: Assumed rate of return Money earned 6.76% Rs. 277.81 7.08% Rs. 290.96 7.36% Rs. 302.47 7.83% Rs. 321.78 (The rates of return are taken from table 1) If you do not need money, as we mentioned earlier and you keep the money in a liquid fund for 10 days, the earnings would be as under: Table 3: Assumed rate of return Money earned 6.76% Rs. 926.03 7.08% Rs. 969.86 7.36% Rs. 1,008.22 7.83% Rs. 1,072.60 (The rates of return are taken from table 1) If in a year, you get four to five such opportunities, we are now talking about serious money. Liquid funds also offer facilities to transact through SMS, increasing the convenience. In fact, just before writing this article, I invested some money in a liquid fund just by sending an SMS. The redemption from the fund account also happens through an SMS. All you need to do is to get a one time mandate registered. So, what are you waiting for? Enjoy your holidays and let your money work for you. The earning would take care of part of the expenses. -        Amit Trivedi The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.