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Arbitrage funds: opportunity for risk-free investments


Who can assure you the guaranteed return on your investment in equity market? Undisputable, no expert investor in equity market can guarantee that you will make profit from every transaction you enter into. Therefore, those investors who do not want to take risk go for investing in arbitrage funds which throw an opportunity for risk-free investments. This is because while the investors entering into the equity market are affected by the turbulence, same situation has been turned into an opportunity by the arbitragers. Find out, how arbitrage funds taking advantage of market turbulence 

In a situation of high and persistent volatility, arbitragers make money by taking advantage of the price differential markets, mostly between the cash and future market. For instance, the stock price of ABC Company is trading at 1000 in the spot market now, where its futures price is Rs.1025.  On settlement day of futures transaction the arbitrager makes profit of Rs.25 for every Rs.1000 invested by him in the spot market. This means the arbitrager, who buys ‘ABCD Company’s share’ in the cash (spot) market and make a risk –free profit by simultaneously selling ‘ABCD Company’s shares’ in the futures market. Market will continue to throw such opportunity on a regular basis and the intelligent arbitrager will make more money with the increase in market volatility. The arbitrage strategy is actually market neutral and low risk business. In the above example of ‘ABCD Company’s share’, you may observe, one is not affected by movement of stock price of ABCD Company in any direction, whether the price has risen or fallen in the interim. Hence arbitrage strategy is less risky, as the arbitragers do only paired trades and profit made by him is pre-determined. As these funds invest predominantly in equities, their tax treatment is at par with equity funds.

Although, arbitrage strategy sounds like a very simple and effective way of making money in the market, retail investors  have to remember that the arbitrage trading  also needs some expert skill and  all retail investors cannot easily do it. Moreover, the returns on this investment may not be as attractive as investment in equity market. Experts say as a category these funds have generated around 9 percent annualized returns in the recent past. This reduction in return is effect of good historical returns generated by arbitrage funds loosing its shine as too many people started chasing this small pie. When demand for an item is high profit margin will naturally come down.

 

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