How do arbitrage mutual funds make profits in volatile markets?

Arbitrage mutual funds make profits in volatile markets by exploiting price differences of the same security in different markets or forms. These funds buy stocks in the cash market and sell them in the futures market simultaneously, benefiting from short-term inefficiencies. Even in uncertain conditions, arbitrage funds generate low-risk returns through these price gaps, offering stability for conservative investors.

1. What Are Arbitrage Mutual Funds?

Arbitrage mutual funds are hybrid schemes that take advantage of price differences between cash and derivative markets. They aim to lock in small profits with minimal risk, making them ideal during periods of high volatility or uncertain market direction.

Example:

If Stock A is trading at ₹500 in the cash market and ₹510 in the futures market, the fund will buy in the cash market and sell in the futures market to earn a risk-free ₹10 margin.

2. How Do They Work in Volatile Markets?

Volatile markets often cause price mismatches between the cash and futures markets. Arbitrage funds capitalize on these mismatches. Here's how:

• Buy a stock in the spot (cash) market at a lower price.
• Sell the same stock in the futures market at a higher price.
• When the future contract expires, the price difference becomes profit.

Since both buy and sell happen simultaneously, the exposure to market direction is minimal.

3. Why Are Arbitrage Funds Safe in Market Volatility?

Arbitrage funds don't rely on market movement for gains. Their returns come from price gaps. This makes them:

• Low-risk: Because trades are hedged.
• Tax-efficient: Treated as equity funds for taxation, giving better post-tax returns if held for 12+ months.
• Better than liquid funds: Especially when market volatility is high.

4. Benefits of Arbitrage Funds in Volatile Markets

• Stable Returns: Even when markets are unpredictable, price gaps offer steady profits.
• Low Risk: Hedged trades reduce exposure to market swings.
• Tax Advantage: Gains are taxed like equity funds, which is lower than debt fund taxes.
• Good for Parking Funds: Suitable for short-term investments with better returns than savings accounts.

5. Risks and Limitations

While considered safe, arbitrage funds have some limitations:

• Returns may be lower in stable or trending markets where arbitrage opportunities are fewer.
• They depend on liquidity and timing.
• Short-term exit loads may apply if redeemed quickly.

6. When Should You Invest in Arbitrage Mutual Funds?

Arbitrage funds are ideal for:

• Short to medium-term investments (3 months to 1 year).
• Times of high market volatility.
• Investors looking for low-risk and tax-efficient returns.
• Parking idle funds with better safety than direct equity.

They're not suitable when markets are moving steadily in one direction, as arbitrage spreads shrink in such periods.

7. Key Takeaways for Investors

• Arbitrage funds use price differences in cash and futures markets to generate returns.
• They are low-risk, tax-efficient, and work well during volatile periods.
• Ideal for conservative investors or short-term parking of money.
• Returns depend on market volatility and arbitrage opportunities.

Arbitrage mutual funds shine during market uncertainty. If you're an investor looking for low-risk options that benefit from volatility without directly betting on market direction, these funds are worth exploring. Use trusted platforms like Angel One to compare and invest in the best arbitrage mutual funds that suit your risk profile and investment horizon.