Arbitrage Funds Vs Liquid Funds: What Is Better?

Mutual fund investors generally invest in liquid funds, ultra short term funds, overnight funds, and arbitrage funds for their short term investment goals.

The main reason for this is the high liquidity and low risk that these funds offer compared to other mutual funds. These are features of most debt funds. Except, arbitrage funds aren’t debt funds!

While liquid funds, ultra short term funds and overnight funds are debt funds, arbitrage funds are hybrid funds that only invest a part of their capital in debt instruments. 

In this story, we will put arbitrage funds under the microscope by comparing them to one of the most popular short term investment options, liquid funds.  

What Are Arbitrage Funds?

It would help to know what arbitrage means before talking about arbitrage funds. In short, arbitrage means buying a commodity at a lower price and selling the same commodity for profit elsewhere.  

This is what arbitrage funds do - they leverage arbitrage opportunities, that is, the difference in the price of shares across markets, to generate returns. An arbitrage fund invests at least 65% of its money in equity. 

Arbitrage funds are known to generate 4-7% returns over the long term. However, arbitrage funds can be very volatile over the immediate short term (1 day or 1 week). 

In certain extreme conditions, arbitrage funds can even generate negative returns. Read this blog to know more about arbitrage funds in greater detail. 

What Are Liquid Funds?

Liquid funds are debt funds that invest in debt and money market securities like corporate bonds, treasury bills, commercial paper, government securities, etc. 

A liquid fund’s portfolio matures in 91 days (on average). This makes it the ideal investment for the short term ranging from 1 day to 3 months. Liquid funds are known to generate 4-6% returns.

Investors are known to rely on liquid funds for the short term either to park their surplus cash or to move money to an equity fund using a Systematic Transfer Plan.  

Liquid funds are considered to be one of the most stable and safe mutual funds due to the short maturity period and the quality of good debt instruments they invest in.   

Read more about the 10 best liquid funds in India for 2021 here. You can also consult a Cube Wealth coach or download a Cube Wealth application. 

Arbitrage Funds Vs Liquid Funds: Key Differences

We've spoken about what arbitrage funds and liquid funds invest in and how they function, in general. Let's move on to the main differences between arbitrage funds and liquid funds.

Difference #1. Risk

Liquid funds are considered safer than arbitrage funds. A liquid fund invests in debt instruments with a short maturity period (91 days). An arbitrage fund invests in equity and relies on arbitrage opportunities.

Watch this video to know why it’s important to know your risk level

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Difference #2. Returns

Both liquid funds and arbitrage funds deliver similar returns over the long term in the range of 4-7%. However, arbitrage funds can use arbitrage opportunities to deliver better short term returns. You can also consult a Cube Wealth coach or download a Cube Wealth application. 

Difference #3. Tax

Arbitrage funds may be more tax-efficient than liquid funds based on your tax bracket. This is because arbitrage funds are treated as equity funds during taxation. 

‍Read more about the tax-saving mistakes you should avoid in 2021. 

Difference #4. Expenses

Arbitrage funds may have a comparatively higher expense ratio than liquid funds due to the heavy reliance on the fund manager’s ability to use arbitrage opportunities to deliver profits.  

Difference #5. Liquidity

Liquid funds, as the name suggests, are better than arbitrage funds in terms of liquidity. You can withdraw your money from a liquid fund in 1-2 days while it might take 3-5 days to withdraw money from an arbitrage fund. Some liquid funds even have an instagram redemption feature. 

Differences At A Glance

Both arbitrage funds and liquid funds may generate returns than a bank savings account or fixed deposit and carry a lower risk compared to other mutual funds. 

Are Arbitrage Funds Better Than Liquid Funds?

An arbitrage fund may generate comparatively better returns than a liquid fund. But a liquid fund is generally more stable and consistent in terms of returns than an arbitrage fund.

Liquid funds have considerably higher liquidity than arbitrage funds. Most liquid funds do not charge an exit fee for redemption after 7 days. However, an exit fee is applicable when it comes to arbitrage funds. 

But arbitrage funds are more tax-efficient than liquid funds because they are taxed just like equity mutual funds. In conclusion, whether or not you should invest in either fund depends on your goals.  

How To Invest In The Best Arbitrage Funds And Liquid Funds?

There are two ways to invest in arbitrage funds and liquid funds in India. One is offline and the other is online.

1. Offline

This method would require you to travel to your nearest bank or AMC office. After reaching, you'll have to do a KYC and then fill up a form with the desired arbitrage fund(s) and liquid fund(s) from 100+ scheme variations that you want to invest in.

2. Online

You can use investment apps to buy and sell arbitrage funds and liquid funds from the comfort of your home. In fact, apps like Cube make it easier to invest in the right mutual funds with advice from Wealth First, experts who've outperformed the market over the past decade.

Here’s a small list of the best arbitrage and liquid funds currently being recommended on Cube:

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Note: Facts & figures are true as of 20-10-2021. All information mentioned is for educational purposes and relies on publicly available information. None of the information shared here is to be construed as investment advice. We strongly recommend you consult a Cube Wealth coach before investing your money in any stock, mutual fund. PMS or alternative asset.

FAQs 

1. What are arbitrage funds?

Ans. Arbitrage funds are a type of mutual fund that aims to profit from price differentials between the cash (spot) and derivatives (futures and options) segments of the market.

2. How do arbitrage funds work?

Ans. These funds buy securities in the cash market and simultaneously sell equivalent contracts in the derivatives market to take advantage of price variations. The goal is to lock in a risk-free profit.

3. Are arbitrage funds entirely risk-free?

Ans. While arbitrage funds are considered low risk, they are not entirely risk-free. Factors like market volatility, changes in tax regulations, and fund management can affect returns.

4. How are arbitrage fund returns taxed?

Ans. In India, arbitrage fund returns are taxed as short-term capital gains if the holding period is less than one year and as long-term capital gains if held for more than one year. The tax rates and treatment may vary based on current tax laws.

Conclusion 

In conclusion, arbitrage funds offer investors a unique and relatively low-risk investment opportunity in the world of mutual funds. These funds aim to profit from price differentials between the cash and derivatives segments of the market, providing a way to potentially generate returns while maintaining a degree of safety.

Arbitrage funds are known for their ability to deliver steady and consistent returns, often outperforming traditional debt investments while carrying lower volatility than equity funds. They serve as a suitable option for investors seeking an investment avenue that bridges the gap between fixed-income and equity investments.

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