A lot of investors get scared when the market is unstable. Prices change quickly. Stocks can change a lot in just one day. People think it is unsafe to invest in stocks during the current economic situation.
Certain mutual funds exist to perform successfully during this specific market condition. For example, there are arbitrage funds. These funds don’t depend on long-term price growth; instead, they use price differences in the market to make money.
Let’s find out why arbitrage funds do well in markets that are always changing.
What Are Arbitrage Funds?
Arbitrage funds operate as mutual funds which generate profits through their investment strategy of purchasing and selling assets across different markets that show price discrepancies.
The cash market values the stock at a different price than the futures market which creates a pricing difference between the two markets.
An arbitrage fund manager has the option to:
- The manager will purchase the stock through the cash market.
- Sell the same stock for a higher price in the futures market.
This makes sure that you make a small profit. The arbitrage spread is the difference in price between the two markets.
The fund doesn’t care much if the market goes up or down because both positions cancel out the risk of the market.
How Arbitrage Funds Make Money
Arbitrage funds make most of their money by taking advantage of small but regular price changes.
This is how the process usually goes:
- A stock is worth ₹100 in the cash market.
- The futures contract for the same stock is worth ₹102.
- The fund buys the stock for 100 rupees.
- At the same time, it also sells the futures contract for ₹102.
The two prices get closer together when the futures contract ends. The fund keeps the difference.
These chances come up in the market a lot of the time. The manager of the fund keeps doing the same thing.
Why Volatility Makes More Opportunities
Prices change more and more often when the market is very volatile. This makes the gap between cash and futures prices bigger.
When prices go up and down quickly:
- The gaps between arbitrage get bigger.
- There are more price differences.
- There are more chances to make trades.
This is why arbitrage funds might do better when the market is unstable.
Prices tend to stay the same when the market is calm. This might make it less likely that you will make money.
Lower Risk Compared to Equity Funds
One great thing about arbitrage funds is that they are safer.
The fund buys and sells the same stock at the same time, which makes it less likely that the market will go in the wrong direction.
Some of the most important benefits are:
- Not as volatile as equity funds
- Low chance of losing money
- Returns that are steady and easy to guess
When the market is unstable, this makes arbitrage funds attractive.
Tax Breaks for Equity
In many places, arbitrage funds are taxed the same way as equity mutual funds.
This means that investors might want:
- Lower capital gains tax rates
- Returns that are better for taxes than funds that lend money
Some investors might think that arbitrage funds are a good short-term investment because of this.
Suitable for Short-Term Investors
People who want to use arbitrage funds often do so because
- A place to keep money for a short time
- Not as risky as funds that only buy stocks
- Better tax treatment than some fixed-income options
They can be good for investments that last between three and twelve months, but investors should always check the fund’s exit rules.
Things to Think About
Arbitrage funds are generally stable, but investors should still think about a few things:
- Returns are usually not very high, but they are not too low either.
- The market’s health affects the chances of success.
- Some funds may charge you to take money out early.
It’s always a good idea to read over a fund’s strategy before putting money into it.
Final Thoughts
Arbitrage funds are different from regular equity funds. They don’t bet on stocks going up; instead, they make money by buying and selling stocks at different prices in different markets.
When the market is very volatile, these price gaps happen more often. This makes it more likely that arbitrage strategies will work.
Arbitrage funds can give you steady, low-risk returns when the markets are hard to predict because of this.
If you want to find a balance between safety, liquidity, and tax efficiency, arbitrage funds can be a good addition to a portfolio that already has a lot of different types of investments.
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