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Mutual funds come in the form of a wide range of investment options, such as equity funds, debt funds, hybrid funds, and solution-oriented funds. Each of these options is designed to suit the different needs of different investors. You may choose the mutual fund scheme that suits your risk appetite, financial goals and investment horizon.
You may prefer investing in liquid funds, overnight funds, short durations funds, or arbitrage funds to manage your short-term investment needs, as such funds carry relatively lower investment risk. Liquid funds are among the most popular investment category in debt funds. They have an aggregate AUM of ₹3.89 lakh crores as of February 28, 2022. Source: AMFI – Association of Mutual Funds in India.
This is the highest in any mutual fund category across equity or debt funds, around 10% of the industry AUM.
In contrast, arbitrage funds are hybrid funds with an aggregate AUM of ₹1.02 lakh crores as of the same date. Such funds invest across debt and equity, but with a minimum 65% investment in equity & equity-related instruments.
Here is a comparison between liquid funds and arbitrage funds to help investors like you make an informed decision:
Investment objective
Liquid funds invest in debt and money market securities with maturity of up to 91 days. In contrast, arbitrage funds invest across debt and equity and aim to generate returns through arbitrage opportunities in the cash and futures market, thus maintaining fully hedged positions.
Investment risk
With liquid funds, there is minimal credit risk and interest rate risk since they invest predominantly in sovereign and money markets for up to 91 days. In contrast, arbitrage funds maintain fully hedged investment positions by holding reverse positions in the cash and futures market. Thus, there is almost no investment risk for such fully hedged positions in arbitrage funds.
Returns
When it comes to the short-term investment of funds, investors tend to rely on debt funds like liquid funds when pitched against hybrid funds like arbitrage funds. The returns from liquid and arbitrage funds may be similar over the long term.
Arbitrage funds may generate relatively better returns than liquid funds, but liquid funds tend to be relatively stable and consistent when generating returns for investors.
Liquidity
Liquid funds provide better liquidity to the investment of short-term surplus funds. The redemption transaction for liquid funds is processed in a shorter turnaround time. The redemption proceeds are transferred to the investor's bank account on the next working day if the transaction has been received before the cut-off time.
In contrast, arbitrage funds' redemption proceeds are generally transferred on a T+2/ T+3 basis. Thus, the investors may receive funds from liquid funds 1-2 days in advance compared to arbitrage funds.
Expense ratio
Liquid funds carry relatively lower expense ratios than arbitrage funds since liquid funds' investment profile is relatively more straightforward. Liquid funds invest predominantly in the money market and sovereign securities.
In contrast, investment managers handling arbitrage funds need to spot arbitrage opportunities and capitalize on such opportunities to generate risk-free returns for the investors. Further, the portfolio turnover ratio will also be higher, leading to higher transaction charges. This results in higher fund management and investment handling charges for arbitrage funds.
Exit load
Investors may have to pay an exit load if the mutual fund units are redeemed within seven days of investment. In contrast, investments in arbitrage funds carry an exit load for a more extended period.
Such period ranges from 21 days to 3 months in arbitrage funds. As such, liquid funds may be better if the investment period is less or uncertain.
Tax efficiency
Short-Term Capital Gains (STCG) from liquid funds are taxable at the regular tax rates. However, if the investors hold such units for more than 36 months, such gains are classified as Long Term Capital Gains (LTCG) and taxed at 20% after indexation benefit.
Indexation increases the investment cost for the inflation prevailing over the period while calculating the taxable gains, thus taxing only the actual returns (net of inflation). In contrast, arbitrage funds are equity-oriented funds that carry special tax rates for capital gains.
STCG from arbitrage funds held for less than 12 months is taxed at 15%, while LTCG from such funds held for 12 months or more is taxed at 10%. Additionally, LTCG of Rs. 1 lakh from equity shares and equity-oriented funds in a year is tax-exempt. The returns from arbitrage funds are tax-efficient compared to liquid funds.
With both these categories of mutual funds schemes carrying their respective objectives, the investors may choose between these depending upon their investment goals and investment horizon.
Note: The tax provisions mentioned in the article are for illustrative purposes only and are updated as per the Union Budget 2022 presented in the Parliament in February 2022. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the investment date.
Disclaimer-
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
To know about the KYC documentary requirements and procedure for change of address, phone number, bank details, etc. please visit https://www.utimf.com/servicerequest/kyc. Please deal with only registered Mutual funds, details of which can be verified on the SEBI website under "Intermediaries/market Infrastructure Institutions". All complaints regarding UTI Mutual Fund can be directed towards service@uti.co.in and/or visit www.scores.gov.in (SEBI SCORES portal). This material is part of Investor Education and awareness initiative of UTI Mutual Fund.
