Funds that protected your Money in the Storm

In the one-year period ending September 23, 2008, you should credit yourself as a good fund manager if you have not lost any money, let alone got some returns. Which coveted mutual funds in India also managed to perform the same feat? Among the mutual fund investment arena in India, debt funds for sure.

Equity mutual funds as an investment? None of you would even hazard a guess. This is understandable considering that during this period, the benchmark index Sensex lost about 20 per cent of its value. But a category of equity funds braved this storm: arbitrage funds.Only 10 equity funds managed to stay afloat in the one-year period ending 23, September 2008. And within this pack, the first seven positions in the list were taken by arbitrage funds. The rest went to pharma funds. Topping this list is UTI Spread Fund (Growth) with gave a return close to 9 per cent. It was followed by JM Arbitrage Advantage Fund (Growth), which also rose more than 8 per cent. 

The other arbitrage funds in the list are ICICI Prudential Blended Plan - Option A (Growth); Kotak Equity Arbitrage Fund – Growth; SBI Arbitrage Opportunities Fund – Growth; HDFC Arbitrage Fund - Plan B (Institutional) – Growth; and HDFC Arbitrage Fund - Plan A (Regular) – Growth.This category of equity funds try to provide capital appreciation through arbitrage opportunities between the cash and derivative market. Arbitrage funds primarily invest in equity and equity-related securities, and derivatives. The rest is parked in debt securities.

How did these funds manage to sail smoothly in the rough weather? Well, the modus operandi of these funds provided a safety net. Arbitrage funds prey on pricing gap between the cash and future market. For example, a stock X is trading at Rs 100 in the cash segment and Rs 102 in the futures market.

The fund manager enters into a futures contract to sell the stock at Rs 102 and buys at Rs 100 in the cash segment. Meanwhile, irrespective of the market movement till the futures settlement day or until he squares off the position, the fund manger makes a profit of Rs 2 on a stock. Similarly, the fund manager can also make profit even if the futures are trading at a discount to the spot prices. These funds offer a low-risk way of benefiting from the equity markets. As the risk profile is relatively low, the returns are moderate.

On top of that, arbitrage funds offer the tax advantage as that of equity funds. As arbitrage funds invest mostly in equity or equity-related instruments, they are treated as equity funds. So they attract lower short-term capital gain tax of 10 per cent and are completely tax-free after one year. Though the top-performing debt funds during this period offered higher returns than arbitrage funds, the debt funds don’t offer that tax advantage. For long-term capital gains, debt funds are taxed at 10 per cent without indexetion or 20 per cent with indexation, whichever is lower, plus 10 per cent and 3 per cent cess. This translates to 11.33 per cent without indexation, or 22.66 per cent with indexation. And for short term capital gains, debt funds are taxed at 33.39 per cent vs 10 per cent for equity funds.