NFO review: Sundaram Arbitrage Fund promises tax efficiency combined with liquidity

The NFO period opened on January 16 and will close on January 30; arbitrage funds are often pitched as alternatives to liquid funds

Kumar Shankar Roy Jan 23, 2020

Arbitrage fundsSundaram Mutual Fund has launched a new fund offer, Sundaram Arbitrage Fund. Arbitrage funds are possibly the lowest-risk equity-oriented funds. The NFO period for Sundaram Arbitrage Fund started on January 16 and is slated for closure on January 30. The scheme will then re-open for continuous subscription on February 10.

This product is an open-ended scheme investing in arbitrage opportunities. For the investor, this investment strategy aims to generate income with minimal volatility by investing in equity, arbitrage strategies which fully offset the equity exposure and investments in debt instruments. Let us take a detailed look at the new offering. Read on.

Arbitrage funds in detail

Arbitrage funds invest in equity and equity-related instruments by identifying and exploiting price discrepancies in cash and derivative segments of the market. These investments by nature are volatile as the prices of the underlying securities are affected by various factors such as liquidity, time to the settlement date, news flow, spreads between cash and derivatives market at different points of time, trading volumes, etc.

Arbitrage funds do not have any net long equity and all equity positions are hedged fully i.e. the equity portion of the scheme is hedged 100% at all times.

Arbitrage funds have been pitched by the MF industry as a worthy alternative to liquid funds post some recent changes. Market regulator SEBI recently announced that all debt securities with maturities beyond 30 days would have to be marked to market. To meet these requirements, many fund managers have reduced the duration of the portfolio to 30 days. Consequently, the shift in their portfolio to shorter-term papers to avoid mark-to-market risks of their portfolios is said to impact returns from liquid schemes.

The 5-year liquid fund category average return is 7% at present compared to 6.3% of arbitrage funds. However, arbitrage funds on a post-tax basis have the potential to generate a higher return as they are treated as equity funds for the purpose of taxation.

Sundaram Arbitrage Fund strategy

Under normal circumstances, Sundaram Arbitrage Fund will have 65%-100% of equity and equity-linked assets, 65-100% of derivatives and 0-35% in debt securities, money market securities, and cash equivalents.

The exposure to derivatives taken against the underlying equity investments should not be considered for calculating the total asset allocation. Exposure is calculated as a percentage of the notional value to the net assets of the scheme. The scheme will use derivatives for trading, hedging and portfolio balancing.

The cumulative gross exposure to equity, debt, money market instruments and derivatives shall not exceed 100% of the net assets of the scheme.

The margin money requirement for the purposes of derivative exposure will be held also in the form of term deposits, cash or cash equivalents.

Do note that the scheme fund managers, S Bharath and Rohit Seksaria, will seek to raise the equity-arbitrage exposure if the environment is conducive. this process of rebalancing may take place in a dynamic manner on a regular basis. Cash calls (with deployment in appropriate money-market and fixed-income securities), derivatives, changes in the degree of overweight and underweight to sectors and changes in
allocation levels to stocks with varying attributes be used to balance the portfolio.

If the macro-economic conditions and market levels warrant, the fund managers may on an exceptional basis, reduce the equity arbitrage exposure and raise the fixed-income component of the portfolio beyond the asset allocation boundary indicated for normal circumstances. Such an allocation in exceptional circumstances shall be adopted with the approval of the internal investment committee of Sundaram Asset Management.

In the event of deviations, the fund manager will carry out rebalancing within 30 days.

Fund benchmark – NIFTY 50 Arbitrage Index

Exit load – For redemption within 15 days from the date of allotment, Sundaram Arbitrage Fund charges 0.25% load. For redemption on or after 15 days from the date of allotment, there is nil load.

Arbitrage funds competitive landscape

There are two dozen arbitrage funds in the market.

The largest ones are Kotak Equity Arbitrage, ICICI Pru Equity Arbitrage, IDFC Arbitrage, Nippon India Arbitrage, and HDFC Arbitrage.

The cheapest arbitrage funds, in terms of the expense ratio, are BOI AXA Arbitrage, ITI Arbitrage, ABSL Arbitrage, Axis Arbitrage, and Union Arbitrage.

In the last 1-year period, best-performing arbitrage funds are Tata Arbitrage (7.14%), DSP Arbitrage (7.12%), Edelweiss Arbitrage (6.86%), IDFC Arbitrage (6.83%) and Nippon India Arbitrage (6.81%).

RupeeIQ take

Many conservative investors who are in higher tax brackets earn higher tax-efficient returns in arbitrage funds.

Given the volatility in arbitrage markets, investors should have at least six months horizon for investing and redeeming from arbitrage funds.

Short-term capital gain taxes applicable on arbitrage funds is 15%, and 10% on dividend income compared to about 34% on liquid funds.

Kumar Shankar Roy

Kumar Shankar Roy is contributing editor with RupeeIQ. Kumar is a financial journalist, with a functional experience of 15 years. He tracks mutual funds, insurance, pension, PMS, fixed income/debt and alternative investments markets closely. He has worked for The Times of India, The Hindu Business Line, Deccan Chronicle Group, DNA, and Value Research, among others, across different cities in India. He is deeply interested in marrying data insights with actionable opinion. He can be contacted at [email protected].

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