One would think that mutual funds are always on the lookout to increase their assets under management (AUM). And there is a lot of truth in that. So it is surprising to come across funds that have actually stopped accepting fresh investments into their schemes.
Kotak Equity Arbitrage, ICICI Prudential Blended Plan A and ICICI Prudential Equity and Derivative Income Optimiser Plan (both retail and institutional plans) have suspended new sales. Ever since 1 July, fresh or additional purchases and switch-ins have not been permitted. However, existing investors who had chosen the systematic investment plan (Sip) can continue to invest regularly. Those who had opted for the Systematic Transfer Plan (STP) too will not see this ruling affect them.
The common thread
What’s common among these three? They are all arbitrage funds. The profit strategy of such funds is that they exploit the difference between the prices of an instrument in different markets. In these cases, it will be the price of one stock in the cash and derivatives segment. For instance, let’s assume that Reliance Industries Ltd’s price in the cash segment is quoting less than the price of its futures contract. In such a scenario, the fund manager can buy the stock in the cash market at a lower price and sell its futures contract at a higher price. The profit will be the difference between the cash price and futures price. As the expiry date approaches (the last Thursday of every month), the difference between the two narrows and the position is unwound and the profit booked.
Why the cap?
The reason that these funds have resorted to capping inflows is probably because of the size of the fund. Generally, it has been observed that when the asset size of a fund grows, the manoeuvrability of the fund manager decreases substantially and he finds it all the more difficult to exploit newer investment opportunities, especially arbitrage ones. In fact, Kotak Equity Arbitrage is the only fund that has been transparent enough to state that both the prevailing market situation, coupled with the large size of the fund, has led it to suspend fresh purchases.
The average AUM (AAUM) of the arbitrage funds category in July stood at Rs 6,026 crore. Considering that this is a 148% increase from March, when the AAUM stood at Rs 2,425 crore, it is obvious that investors are flocking to these schemes.
Kotak Equity Arbitrage fund was the largest (Rs1,006 crore) in terms of AAUM. Following, not very closely, was HDFC Arbitrage Wholesale, which held Rs765 crore of AAUM. ICICI Prudential Equity and Derivative Income Optimiser Plan and ICICI Prudential Blended Plan A are much smaller, with assets of Rs414 crore and Rs428 crore, respectively.
While this is disappointing for new investors, current investors have a new issue to grapple with. These funds are categorized as equity and get the same tax treatment as other equity funds. Now arbitrage funds do well in volatile markets when there is scope for price discrepancies. If there are no viable opportunities, the fund manager will tend to park the surpluses in debt. Naturally, if the fundamental character of the fund changes, so will the tax implications. In a debt fund, long-term capital gains are no longer tax-free and stand at 10% (without indexation) or 20% (with indexation)—not a happy turn of events.
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