SBI Mutual Fund's latest new fund offer - SBI [Get Quote] Arbitrage Opportunities Fund, is an open-ended equity scheme that aims to provide capital appreciation and regular income for unit holders by identifying profitable arbitrage opportunities between the spot and derivative market segments as also through investment of surplus cash in debt and money market instruments.

Given that it's an Aribitrage Fund, investors should be very clear that they aren't investing in an equity product but instead in a market neutral fund i.e. the returns will not be dependant on which way the market moves.

Who should invest?

SBI Arbitrage Opportunities Fund is an alternative apart from Fixed Maturity Plans and Floating Rate schemes to beat the risks inherent in income schemes. Those wanting a breather from the equity market and those looking for safe fixed income should invest. (Also read - Why should one invest in Arbitrage Funds?)

Experts believe that this fund is suitable for those conservative investors who may like to enhance returns on their portfolio without changing their risk profile. Advisor Hemant Rustagi says, "As the scheme intends to hold spot market positions only for the purpose of arbitrage opportunities, risk gets eliminated. The fund should be able to deliver better returns compared to floating/liquid funds."

Tax Benefits

Another significant feature is that investors will be entitled to tax benefits that are available to equity fund investors i.e. tax free dividend, short term capital gains to be taxed at 10 per cent and tax free long term capital gains. In case of non-equity MFs (if equity component is less than 65 per cent), dividends will be subject to only a 14.025 per cent distribution tax, thereby again creating an arbitrage opportunity for taxpayers in the highest bracket. If one chooses the growth option and stays invested for over 1 year, capital gains tax @10 per cent or @20 per cent with indexation has to be paid.

On the flipside..

Lack of Arbitrage Opportunites

Investment expert Sandeep Shanbhag feels that the biggest risk with arbitrage funds remains the possibility of not finding enough arbitrage opportunities in the market.

However, David Pezarkar, Fund Manager of SBI Arbitrage Opportunities Fund believes that with the dynamics of this market moving in the same direction as short-term interest rates, adequate arbitrage opportunities are available in the current market scenario. He said, "The process of arbitrage essentially consists of lending money to the market, and on a broader basis, this avenue should yield a return, which is at a premium to a comparable risk-free fixed income instrument.

"Any situation which deviates from this theme is possible in the short term and would correct itself soon enough for the fund to profitably deploy its assets. Volumes have been increasing on both the cash and derivative markets, with the latter now trading close to three times the underlying cash volumes.

"Institutional money deployed for exploiting arbitrage opportunities does not yet constitute a very significant proportion of market volumes. These arbitrage opportunities would keep arising on sufficient occasions to enable the fund attain its desired returns."

Cost Issues

"Each transaction in the stock market involves payment of brokerage and security transaction tax. These costs directly dilute the earnings. Each leg of the entire transaction i.e. buying stock, selling future, selling stock and buying futures will entail the payment of these costs.

"Therefore, it again comes down to the presence of the arbitrage opportunity and it being meaningful enough i.e., after the payment of the expenses, the left over profit if any, should be material enough to make the transaction worth entering into," says Shanbhag.

However, Pezarkar clarifies, "Currently there are derivatives on three indices. Past experience has shown that a certain set of stocks provides a good cost of carry, i.e. a positive arbitrage on a consistent basis, over a sufficiently long period of time, which would address the issue of transaction costs.

"An arbitrage portfolio, which has a significant component of stocks requiring only the futures leg rollover, would be able to minimize the impact of the cash market transaction costs, and thus achieve superior returns."

Why choose SBI Arbitrage Opportunities Fund over existing similar schemes?

Pezarkar has an answer to that, "A key differentiator between funds will be the ability to capture the evident arbitrage without significant slippage, and construct a portfolio that has a high component of stocks with a consistently good cost of carry.

"SBI Mutual Fund has successfully managed a large equity portfolio over the past few years, and has derived a deep understanding of the cash and derivative markets during this period. Our experience in managing this asset size and our strong position will enable us to exercise a sufficient leeway so as to drive down the variable costs associated with arbitrage transactions."

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