Ever since the Budget announcements pertaining to tax changes on debt funds, arbitrage funds have suddenly come into the limelight, as a tax efficient alternative for parking short term surpluses. Skeptics suggest that this is not really a viable alternative, as the category is too small and will quickly become a victim of its own success as increased flow into arbitrage funds will kill arbitrage opportunities. How real is this threat? How relevant can arbitrage funds become as an alternative for your clients' short and medium term surpluses? Vikaas Sachdeva provides a perspective on a product category whose time has perhaps finally come.

WF : We had written an article in June 14 (Click Here), wondering why arbitrage funds were not getting their due attention, and now, a month later, thanks to the tax changes for debt funds, everyone seems to be talking about arbitrage funds. How much of this is initial enthusiasm and to what extent can this become a game changer for the arbitrage funds category?

Vikaas : The changes announced in this year's budget regarding the Debt Mutual Fund taxation will definitely benefit the Arbitrage Funds as a category. However, we have always believed that Arbitrage Funds on a standalone basis itself has a lot of merits. We had identified this as a category which, for all its benefits, was underserved and thus launched the NFO in June 2014.

So, irrespective of the changes announced in this year's budget, we think it is a category which will find its own space in the Investor's portfolio.

WF : Many experts believe that this category is too small and that it will become a victim of its own success, as more money will come in and effectively wipe out arbitrage opportunities in the market. How valid is this concern? How large can this category grow to, before it starts meaningfully impacting returns?

Vikaas : The participation in the derivatives market has been increasing over a period of time. For example, the Open Interest in Stock Futures has doubled since last year from approx. 25,000 crore to close to 60,000 crore now. As the participation increases, so does the arbitrage opportunities.

Currently, there are about 135 stocks trading in the F&O segment. With increased bullishness, the exchanges may increase the universe of stocks which trade in this segment. This should keep the arbitrage segment lively.

While the segment cannot assume the size of the entire Liquid Funds category, there is still some way to go before we can get worried about the returns being impacted significantly.

Assuming the returns of this category fall by 100bps from current levels, it will still be much better than Liquid funds on a post tax basis.

WF : What is Edelweiss Group's presence in the arbitrage business? What market share does your group currently account for?

Vikaas : Edelweiss as an Enterprise is known as a pioneer in the F&O segment in India and is a dominant player in this segment. The group is among the largest players in the Arbitrage category. The group runs a significant portion of its Proprietary book on arbitrage strategy. Hence it was only logical and timely for us, to launch this fund at a time with immense positivity in sentiment.

WF : In what ways do you see arbitrage funds changing to deal with the new found enthusiasm for this category?

Vikaas : We are happy to see Investors and Distributors warming up to this category. For investors with a medium to long term investment horizon, this category offers an immense potential. Arbitrage opportunities exist in all market conditions, helping investors generate relatively better risk-adjusted returns across market cycles.

With its equity orientation, the dividends are tax free and the capital gains , if the units are held for more than one year, are tax free too, making it more tax efficient than Liquid and Debt Schemes. We think, Arbitrage funds should be a part of all asset allocation strategies.

What we are witnessing is the emergence of Arbitrage Funds as a liquid-proxy investment solution and it will go a long way in providing the investors a tax-efficient investment option for medium to long term horizon.

DISCLAIMER: Mr. Vikaas M Sachdeva is the Chief Executive Officer of Edelweiss Asset Management Limited and the opinion stated above are his own

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