Best arbitrage mutual funds to invest in 2023

Do you want to park money for a period of a year or more? Are you looking for the best after-tax returns for parking money for year? Consider investing in arbitrage funds. Also, these funds do not invest in debt instruments. So, you don't have to worry about interest rate changes.

Arbitrage funds look for arbitrage opportunities available in the market. In other words, the fund managers in these schemes look for the price difference that they can exploit between the cash and derivatives markets. They may also invest in debt securities and equities if there are no arbitrage opportunities available in the market.

LTCG tax

These schemes also have tax advantages. Arbitrage funds are taxed like equity schemes. They qualify for long term capital gains tax of 10% if investments are held for more than a year. If investments are made for less than a year, a short term capital gains tax of 15% will be applicable.

Sure, arbitrage funds lost some of their sparkle lately because of the dwindling returns. Volatility in the market may help these schemes as it will offer better arbitrage opportunities. If you still invest in arbitrage funds or are considering investing in them, this article may appeal to you.

As said earlier, returns from arbitrage funds got nothing to do with the interest rate regime as they always look for arbitrage opportunities. So they may be suitable for investors who don’t want to take a call on interest rates.

Arbitrage opportunities

However, you should keep in mind that there may be periods when there are not many arbitrage opportunities available in the market. This can happen when the market is headed in a single direction. A volatile market is helpful to arbitrage funds as there will be more arbitrage opportunities available.

Here are our recommended arbitrage funds you may consider investing. There is no change in the list this month as all schemes have retained their place in the list. Watch out for our monthly updates to ensure your schemes are faring well.

Here are our recommended arbitrage schemes you can consider investing to take care of your short-term needs:

Best arbitrage funds to invest

• Kotak Equity Arbitrage Fund
• Nippon India Arbitrage Fund

Methodology
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

(Disclaimer: past performance is no guarantee for future performance.)