New Delhi: Volatility in financial markets is driving investors from debt to arbitrage funds, which take advantage of the price discrepancy between cash and derivatives markets to hedge risk and generate annual returns in the range of 6-9%, wealth managers say.
Arbitrage funds gained an average 0.63% between 25 May and 25 June against the 0.11% returns on debt funds in the same period, according to Value Research, a New Delhi-based mutual fund tracker. Gilt funds, which invest in government securities, declined around 0.3%.
The yield on benchmark 11-year government bonds was 6.85% on Thursday. Sandeep Bhatnagar / Mint
The data is based on the net asset value (NAV) of funds on Wednesday. NAV is the current market value of a fund’s net assets, divided by the number of outstanding shares.
Arbitrage funds go long in the cash market—buy an investment in the expectation that it will rise in value. Simultaneously they go short in the futures market—sell the same investment in the expectation that it will fall in value and can be repurchased at a lower price.
“Our clients are mostly investing in arbitrage funds following the decline in returns from debt funds,” said Satya Narayan Bansal, chief executive of Barclays Securities (India) Pvt. Ltd.
The yield on benchmark 11-year government bonds was 6.85% on Thursday. Prices and yield on bonds move in opposite directions.
The yield on government bonds will rise if the government plans to borrow more money from the market than what it had estimated in the interim budget presented in February.
The interim budget had estimated the annual government borrowing at Rs3.62 trillion, and Rs2.41 trillion is slated to be raised in the first six months of the fiscal. The government borrows from the market to bridge its fiscal deficit.
“Arbitrage funds give tax-free returns which go to 9% against the current 5-6% returns from debt funds,” said Surya Bhatia, a New Delhi-based financial planner.
Since 9 March, when the markets started rising, the Sensex has gained around 76%. On Thursday the Sensex lost 77 points, or 0.53%, to close at 14,345.
“Whenever there is volatility in the market, arbitrage is a better option,” said R.K. Gupta, managing director of Taurus Asset Management Co. Ltd. “With inflation numbers turning negative and interest rates further going down government securities have given negative returns, making arbitrage funds and investment in equity more attractive.”