Difference between arbitrage and equity funds

Mutual funds provide investors with diversified exposure to various assets. By pooling funds from different investors, these funds engage in the acquisition of stocks, bonds, and other securities, ensuring a broad investment spectrum.

However, with this wide variety of options comes a potential roadblock – investing choices can be complex, especially when comparing different fund types. Two popular investment options – arbitrage funds and equity funds – might sound similar, but they are inherently quite different.

Let's dissect their characteristics to identify the ideal vehicle for your investment journey.

• Table of contents

1. Understanding arbitrage funds
2. Understanding equity funds
3. Differences between arbitrage and equity funds
4. Arbitrage Fund vs Equity Fund: Which is a Better Investment Option?

Understanding arbitrage funds

Arbitrage funds can be a suitable option for investors seeking to capitalise on volatile markets while managing risk. Although their returns tend to be modest, arbitrage funds rely heavily on market inefficiencies. These funds are categorised as equity-oriented hybrid funds and they exploit price differentials in various markets, mainly pricing mismatches between exchanges or disparities between spot and futures markets.

This approach contrasts with traditional investing, as the arbitrage fund manager invests in equities and also in equity derivatives when a definite opportunity for returns arises. In the absence of arbitrage opportunities, the fund shifts to short-term money market instruments and debt securities. Notably, the price differences involved are usually minimal, requiring multiple daily trades for a reasonable profit.

Bajaj Finserv Asset Management Limited offers the Bajaj Finserv Arbitrage Fund, an open-ended scheme strategically investing in arbitrage opportunities. The scheme aims to generate returns by capitalising on arbitrage possibilities in the cash and derivatives segments of equity markets, with a balanced investment in debt and money market instruments. The Nifty 50 Arbitrage Index (TRI) serves as the benchmark, indicating the relatively low-risk nature of the principal investment. The scheme is tailored for investors eyeing short-term income and potential gains from arbitrage opportunities. However, it is crucial for investors to consult a financial advisor before making any investment decisions.

Understanding equity funds

Equity funds are an integral part of the investment landscape. They invest your money directly in company stocks, seeking long-term capital appreciation through company growth and dividend pay-outs. Equity Funds cater to diverse risk appetites, offering options from aggressive growth focused on young, high-potential companies to balanced solutions combining relative stability of blue-chip with growth possibilities. While offering the potential for reasonable returns, they also carry higher risk due to market fluctuations and individual company performance.

For example, Bajaj Finserv Asset Management Limited offers the Bajaj Finserv Large and Mid Cap Fund, an open-ended equity scheme strategically investing in both large cap and mid cap stocks. The fund's objective is to foster long-term capital appreciation through a diversified portfolio of equity and equity-related securities, chiefly focusing on large and mid-cap stocks across various sectors. Benchmarked against Nifty Large Midcap 250 TRI, this product caters to investors seeking wealth creation over the long term. The fund provides both direct and regular plans. However, investors should be aware of the high risk associated with their principal.

Differences between arbitrage and equity funds

Here’s a look at some of the key differences between arbitrage funds vs equity funds:

Factor	Arbitrage Funds	Equity Funds
Investment approach	Exploit short-term price gaps	Focus on long-term company growth potential
Risk profile	Lower risk due to predictable price discrepancies	Higher risk due to market and company factors
Return potential	Moderate, consistent returns; lower expected rate in SIP calculators	Higher growth potential but with more fluctuations
Investment horizon	Suitable for short-term goals	Target long-term wealth creation potential

Arbitrage fund vs equity fund: Which is a better investment option?

Choosing between an arbitrage fund and an equity fund depends entirely on your individual financial goals, risk tolerance, and investment horizon. There's no single ‘better’ option as each caters to different investment needs.

Equity funds are considered high-risk investments. However, they also offer the potential for higher returns over the long term.

Arbitrage funds are considered to have a relatively lower risk profile compared to equity funds. However, they are not risk-free. Arbitrage funds typically offer lower potential returns compared to equity funds. Their returns are generally more stable but lower.

Investors with a long-term investment horizon (e.g., 5-10 years or more), a higher risk tolerance, and are seeking potentially higher returns generally prefer equity funds.

Investors with a shorter investment horizon (e.g., 1 year), a lower risk tolerance, and who are looking for relatively stable return potential may choose arbitrage funds.

Conclusion

Choosing between arbitrage and equity funds depends on your risk tolerance and investment timeline. Arbitrage funds offer lower risk and predictable returns for shorter-term objectives, while equity funds unlock the potential for higher returns but demand a longer horizon and tolerance for volatility. Understanding these distinct features and your own financial priorities empowers you to select the optimal route towards achieving your investment goals. Always remember to consult a financial advisor before zeroing in on any investment product.

FAQs:

What is the main difference between arbitrage funds and equity funds?

 Arbitrage funds capitalise on pricing gaps in securities across different markets, while equity funds invest in company stocks for long-term growth.

Which type of fund is more suitable for short-term investments?

Arbitrage funds are suitable for short-term financial goals, while equity funds, due to their inherent volatility, are better for a long-term investment horizon.

Are arbitrage funds less risky than equity funds?

Arbitrage funds exhibit lower risk due to their strategy, while equity funds involve higher market and company-specific risks.

How do arbitrage funds generate returns compared to equity funds?

Equity funds generate returns through the potential appreciation in the value of stocks in the portfolio, among other factors. Arbitrage funds, on the other hand, profit from price discrepancies of the same asset across different markets or exchanges. They seek to capitalise on brief inefficiencies and fluctuations rather than the potential long-term growth of underlying assets.

Can I invest in both arbitrage and equity funds simultaneously?

Yes, investing in both arbitrage and equity funds can be a part of a diversified approach. Equity funds offer potential for long-term growth, while arbitrage funds can provide relative stability and lower risk. Moreover, equity funds are more suitable for long-term goals, while arbitrage funds can suit short-term goals. The specific allocation depends on your risk tolerance and financial goals.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.