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Best arbitrage mutual funds to invest in 2020

Here is our recommended arbitrage mutual funds you may consider to invest your surplus cash for a short period.

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Last Updated: Feb 26, 2020, 02.47 PM IST
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Best arbitrage mutual funds to invest in 2020
Many investors, especially those with deep pockets, love to park their surplus cash in arbitrage mutual funds for short periods. These investors' love for arbitrage funds earlier was mainly because of the tax advantage enjoyed by these schemes. Even after the government started taxing long-term returns from arbitrage funds, investors continue to bank on them.

Debt mutual funds, if sold before three years, attract short-term capital gains tax. The short term capital gains are added to the income of the investor and taxed according to the income tax slab applicable to the investor. Arbitrage funds are treated as equity mutual funds for taxation. If investments in arbitrage funds are sold before a year, the investor need to pay short term capital gains tax of 15%.

Investments in debt mutual funds qualify for long-term capital gains tax only if held for over three years. Long term capital gains on debt mutual funds are taxed at 20 per cent with indexation benefit. The indexation benefit allows investors to inflate the cost of purchase and it helps to reduce the total tax outgo. If arbitrage funds are sold after a year, the investor must pay the long-term capital gains tax of 10%.

If you are new to mutual funds, here is how arbitrage funds work. These mutual fund schemes look to exploit the arbitrage opportunities available between the cash and the future market. Essentially, these schemes look for the price difference between the spot market and derivatives market to earn risk-free returns. The price mismatching would be more in a volatile market. So, volatility works in favour of arbitrage mutual fund schemes.

Arbitrage mutual fund schemes are expected to offer marginally higher post-tax returns than debt mutual funds. However, this will not be the case always. For example, the arbitrage fund category is offering around 5.79% in the last on year, whereas the liquid fund category is offering around 6.04% during the same period.

"If you have an investment horizon of nine months to a year, you can invest in arbitrage funds for lower volatility," says Deepali Sen, Founder, Surjan Financial Advisors. "if you want okay returns with lower volatility, you should go for arbitrage funds," she adds.

Here are our recommended arbitrage mutual fund schemes you may consider to invest:
  • Kotak Equity Arbitrage Fund
  • Nippon India Arbitrage Fund
If you are curious about how we have chosen these schemes, you may go through the methodology :

Methedology
ETMutualFunds.com has employed the following parameters for shortlisting the hybrid mutual fund schemes.

1. Mean rolling returns: Rolled daily for the last three years.

2. Consistency in the last three years: Hurst Exponent, H is used for computing the consistency of a fund. The H exponent is a measure of randomness of NAV series of a fund. Funds with high H tend to exhibit low volatility compared to funds with low H.
i) When H equals 0.5, the series of return is said to be a geometric Brownian time series. These type of time series is difficult to forecast.
ii) When H is less than 0.5, the series is said to be mean reverting.
iii) When H is greater than 0.5, the series is said to be persistent. The larger the value of H, the stronger is the trend of the series

3. Downside risk: We have considered only the negative returns given by the mutual fund scheme for this measure.
X = Returns below zero
Y = Sum of all squares of X
Z = Y/number of days taken for computing the ratio
Downside risk = Square root of Z

4. Outperformance
i) Equity portion: It is measured by Jensen's Alpha for the last three years. Jensen's Alpha shows the risk-adjusted return generated by a mutual fund scheme relative to the expected market return predicted by the Capital Asset Pricing Model (CAPM). Higher Alpha indicates that the portfolio performance has outstripped the returns predicted by the market.
Average returns generated by the MF Scheme =
[Risk Free Rate + Beta of the MF Scheme * {(Average return of the index - Risk Free Rate}
ii) Debt portion: Fund Return – Benchmark return. Rolling returns rolled daily is used for computing the return of the fund and the benchmark and subsequently the Active return of the fund.

5. Asset size: For Hybrid funds, the threshold asset size is Rs 50 crore

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