Arbitrage Funds Shine In 2024, Deliver Best Returns In Nearly A Decade

Arbitrage funds have become the new favorite among individual investors, posting their best performance in nearly a decade in 2024. On average, these funds delivered an 8% return last year, the highest since 2016, according to data from Value Research.

Several factors supported this strong performance, including positive equity market sentiments, a surge in open interest in stock futures, and high interest rates, analysts say.

“Bullish equity market sentiments played a key role in helping arbitrage funds achieve better returns. As more people took leveraged positions, they were willing to offer higher premiums during monthly rollovers,” said Bhavesh Jain, Co-head of Factor Investing at Edelweiss MF.

Jain also pointed to the lifetime high in open interest in stock futures, which crossed Rs 4 trillion, and the stability of relatively high interest rates throughout the year. Furthermore, factors like increased volatility in the second half of the year and better-than-expected dividend payouts also contributed to the fund’s strong performance.

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Arbitrage funds capitalize on price differences between the spot and futures markets. By buying stocks in the cash market while simultaneously selling them in the futures market, they hedge their equity exposure, making them a low-risk investment option.

This strong performance has been crucial for the hybrid category, with debt funds also having one of their best years in 2024. Several longer-horizon debt schemes delivered double-digit returns during the year.

One key advantage of arbitrage funds is their favorable tax treatment. They qualify for equity taxation, meaning any gains from investments held for more than a year are taxed at 12.5%. In contrast, fixed-income investments are taxed at the investor’s income tax slab rate, which can be as high as 30%.

This tax advantage has made a significant impact. While the tax structure for debt funds changed in April 2023, when the government withdrew indexation benefits, the new tax regime has spurred increased interest in arbitrage funds. As a result, the assets under management in arbitrage funds have nearly tripled to Rs 2 trillion, with investors pouring in a net of Rs 1.4 trillion over the last 21 months.

“Arbitrage funds offer debt-like returns with the advantage of equity taxation, making them an attractive option for investors. This has led to a sharp increase in inflows,” said Siddharth Alok, AVP of Investments at Epsilon Money. “However, investors should be aware that returns can be slightly volatile.”

As arbitrage funds continue to gain traction, their growing popularity underscores the changing landscape of investment choices for high-income earners.