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Kolkata: Income plus arbitrage funds is an emerging category of mutual funds in response to shifting investor inclination towards tax efficient alternatives to conventional debt funds. Accordingly, several prominent asset management companies have launched these funds. Among them are Axis Mutual Fund, Baroda BNP Paribas Asset Management India, Invesco Mutual Fund, Nippon India Mutual Fund, Tata Asset Management and SBI Mutual Fund, the last one being the biggest AMC in the country. Aditya Birla Sun Life, HDFC, Kotak Mahindra, HSBC and Bandhan AMC too have reportedly tweaked earlier offerings to combine debt and arbitrage approached.
What are these fund and why are they becoming popular? In short, these are hybrid mutual funds. These are considered hybrid since they combine arbitrage opportunities in equities with debt instruments like T bills, bonds and commercial paper. Let's have a closer look.
In arbitrage, mutual funds exploit the difference between the prices in the cash and derivatives markets. Buying stocks in the cash market and selling them in the futures market can fetch some gains depending on the market. The difference in prices flows in when the contracts expire by reversing the positions. These are combined with the stability of debt securities. Analysts point out that the returns of these funds track the yields on money market instruments.
Usually 65% of the money in the portfolio of these funds is put arbitrage (equity + derivatives) to qualify as equity-oriented from the taxation angle. The remaining 35% is invested in debt instruments to generate returns that are easy to predict. In fact, they have been designed to generate higher returns than short-term debt funds.
The appeal of debt funds was impacted by the Union budget of 2023. If one bought debt funds after April 1, 2023, gains from these schemes that had/have less than 35% in equity are taxed as STCG (short term capital gains) calculated on the investor's income slab tax rate. In other words, they could be taxed at as high as 30%. The rate would reduce to 20% only after three years. There was no indexation benefit too. As a result of this change, investors in debt mutual funds began searching for tax-efficient alternatives.
One of the sectors that got a tax boost was Fund of Funds. Gains from these schemes were taxed at 12.5% as LTCG (long-term capital gains) if held for more than two years. The condition was fund of funds have to contain their exposure to sent within a ceiling of 65%. The Income Plus Arbitrage Funds and the repackaging of existing debt to income plus arbitrage category funds were a response to this changing tax regime and the new demands that it generated.
Significantly, a few AMCs such as Aditya Birla Sun Life , HSBC, Bandhan tweaked earlier schemes. For example, Aditya Birla Sun Life Active Debt Multi Manager FoF was tweaked to Aditya Birla Sun Life Debt Plus Arbitrage FOF, while HSBC Managed Solutions India Growth Fund was changed to HSBC Aggressive Hybrid Active FOF. Two other examples were Kotak All Weather Debt FOF transforming into Kotak Income Plus Arbitrage FOF and Bandhan All Seasons Bond Fund turning into Bandhan Income Plus Arbitrage Fund of Funds.
Obviously these funds have a more complicated structure than traditional debt funds. These offer flexibility to fund managers who can adjust between arbitrage and fixed income instruments depending on the market. These are appropriate for conservative investors since they lack the volatility of equity funds.
(Disclaimer: (Disclaimer: This article is only meant to provide information. TV9 does not recommend buying or selling shares or subscriptions of any IPO, Mutual Funds, precious metals, commodity, REITs, INVITs, any form of alternative investment instruments and crypto assets.))
