What are Arbitrage Funds? A Beginner’s Guide
Arbitrage funds are hybrid mutual funds with arbitrage strategies. These funds take advantage of the price anomalies between related securities in various markets. They capture minor price differences to generate returns that have low risks. Arbitrage funds make arbitrage accessible to retail investors. This article will discuss how arbitrage funds work and why one should invest in them.
What is an Arbitrage Fund?
The goal of arbitrage funds is to profit from short-term price discrepancies between securities in various marketplaces. Professional fund managers oversee these funds with expertise. The fund managers monitor the various markets in real time to identify arbitrage opportunities. The core concept behind arbitrage trading is the buying of undervalued securities and simultaneously selling the overvalued equivalents. Thus, the fund generates returns by exploiting these discrepancies, and the risk is relatively low.
Arbitrage funds come under hybrid mutual funds, which are those investing in both equity and debt. They are profitable on account of inefficiency in the market. This approach is based on reducing risk but trying to earn consistent, low-risk returns from small movements in prices.
How to do Arbitrage Funds Work
Arbitrage funds do not depend on the market direction or speculation. They operate by taking advantage of a price difference between related securities in two different markets. The core of their business is the temporary nature of such differences. When an arbitrage opportunity arises, the fund buys a security in one market and sells it in another at the same time.
The manager hopes to close both positions at that time when the prices align. This is locking in a small, risk-free profit. Arbitrage funds will trade numerous times in the day for such minor price discrepancies. A small return from each trade can sum up into a steady stream of profit from many such trades.
These funds are not bothered about the direction of the overall market. Instead, they seek to exploit inefficiencies that exist between related securities. This helps generate returns that are independent of broader market movements, thus making arbitrage funds less volatile.
Why Invest in Arbitrage Funds: Benefits and Advantages
Arbitrage funds have many benefits that make them an attractive investment option for investors. The benefits include relatively low risk, diversification, and accessibility for common investors.
Relatively Low-Risk Returns
Arbitrage funds exploit temporary price differences, thus it minimizes exposure to market risks. Since the trades are based on price convergence, are less dependent on market conditions and economic factors. The funds have a more stable return, appealing to risk-averse investors.
Diversification
Arbitrage funds have a very low correlation with other traditional asset classes such as equities and fixed income. This makes arbitrage funds an excellent instrument for portfolio diversification. Including arbitrage funds in a stock or bond portfolio reduces the volatility of a portfolio. Because their returns are not at all market trend-dependent, arbitrage funds can often balance risk in investment strategy.
Accessibility
Arbitrage trading cannot be continuously monitored and executed in real time, which poses a challenge for individual investors. However, mutual funds give retail investors access to the knowledge of professional arbitrage traders. The funds pooled from several investors democratize a strategy that was once only possible for large financial institutions.
Alpha in Arbitrage Funds
Arbitrage funds seek alpha by capturing the price differential between related securities. Alpha refers to the excess return an investment generates above a benchmark. Although individual arbitrage trades result in small returns, aggregation of many small gains can make up for higher overall performance. The key to success in arbitrage funds lies in consistently exploiting these pricing inefficiencies over time.
The strategy will be used to provide steady returns by concentrating on small, incremental gains. Although the returns would not be as high as those for equity investments, they do offer more stability. Investors looking for lower-risk returns with predictable returns would find arbitrage funds appealing.
Conclusion
Arbitrage funds are good for investment for a lower-risk return. They are profiting from pricing inefficiencies and are looking for small, consistent gains; they are stable. However, some risk is involved because the price discrepancies they rely on might not always be correct as expected, which could mean losses. Before investing, it’s important to look at your financial goals, your risk tolerance, and time horizon. It’s always wise to consult a financial advisor to ensure these funds align with your investment objectives. For beginners, Axis Mutual Fund App can be a good mutual fund app, it enables new investors, first-time investors (KYC verified), and existing investors of Axis Mutual Fund to make investments anywhere, anytime.
