Arbitrage funds, the new favourite of individual investors, delivered their best performance in nearly a decade in 2024.
On average, the schemes delivered 8 per cent return last year, the highest since 2016, according to data from Value Research.
The returns were supported by positive equity market sentiments, surge in open interest in stock futures, high interest rate, among other factors, analysts said.
"Bullish equity market sentiments helped arbitrage funds to deliver better returns as more and more people wanted to take leverage positions and thereby ready to give higher premiums during monthly rollovers," said Bhavesh Jain, co-head, Factor Investing, Edelweiss MF.
“Open interest in stock futures was at a life-time high and crossed Rs 4 trillion.
"The interest rates during the year were stable and relatively on the higher side," he added, adding that factors like increase in volatility in the second half of the year and better-than-expected dividend payouts also contributed to this trend.
Arbitrage funds capitalise on price differences between the spot and futures markets.
As they buy stocks in the cash market while simultaneously selling them in the futures market, their equity exposure is hedged.
This strategy makes arbitrage funds a low risk option.
The strong showing was crucial for the hybrid category as debt funds also had one of the best years in 2024 with several longer-horizon schemes delivering double-digit returns.
Given the tax advantage, arbitrage funds are likely to have delivered better post-tax returns for high income investors.
Arbitrage funds compete with debt mutual fund schemes and other fixed income investment options for inflows.
However, the tax treatment is different.
Arbitrage funds qualify for equity taxation and hence any gains after the completion of one year of investment is taxed at 12.5 per cent.
In comparison, the gains from fixed income investments are taxed at the investor's income-tax slab rate, which can be as high as 30 per cent.
The tax differential between arbitrage funds and debt funds was not as high until two years ago.
The present tax structure of debt funds has been effective since April 2023 when the government withdrew indexation benefits from debt funds.
The change in taxation in 2023 resulted in increased traction for arbitrage funds.
The assets under management has nearly tripled since then to Rs 2 trillion with investors putting in a net of Rs 1.4 trillion during the 21-month period.
"Given that arbitrage funds offer debt funds like returns with equity taxation, there is an added benefit for investors. This has resulted in a sharp surge in inflows.
"However, investors must understand that returns can be slightly volatile," said Siddharth Alok, AVP Investments, Epsilon Money.
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