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Union Arbitrage Fund: Should You Invest? - Outside View by PersonalFN

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Union Arbitrage Fund: Should You Invest?
Feb 7, 2019

Union Arbitrage Fund is an open-ended arbitrage scheme investing in arbitrage opportunities. The scheme will follow arbitrage strategy and invest at least 65% of its total assets in equity & equity related instruments as per the mandate under normal and defensive conditions. It will also allocate the remaining assets to debt and money market instruments.

An arbitrage fund is a sub-category of Hybrid fund that seeks opportunities from differential pricing in two different segments (spot and futures or cash and derivatives) of the equity market. Such opportunities are usually tapped in volatile market conditions.

Typically, an arbitrage fund is less risky than the pure equity fund because participants are not speculating on market movements. Instead, they bet on the mispricing of a share/asset that has happened between two related markets. It is seen that the mispricing of security is far more frequent in high volatility months than in low volatility months. Lately, the markets have been extremely volatile and Union Mutual Fund wants to tap this potential to generate returns for the investors.

Hence UAF in terms of risk-return potential is moderately low and suitable for investors who are willing to park their money for short-term investment time-horizon of 1-2 years.

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Table 1: NFO Details

Type An open-ended scheme inveting in arbitrage opportunities Category Arbitrage fund
Investment Objective To generate capital appreciation and income by predominantly investing in arbitrage opportunities in the cash and derivatives segment of the equity market, and by investing the balance in debt and money market instruments.

However, there is no assurance that the Investment Objective of the scheme will be achieved.
Min Investment Rs 5,000 and in multiples of Re 1 thereafter Face Value Rs 10 per unit
Plans
  • Direct
  • Regular
Options
  • Growth *
  • Dividend (Reinvestment#, Pay out and Sweep facility)
*Default option
# Default option for Dividend
Entry Load Nil Exit Load
  • 0.25% if units are redeemed or switched out on or before completion of 1 month from the date of allotment of units.
  • Nil if units are redeemed or switched out after completion of 1 month from the date of allotment of units.
Fund Manager Mr Vishal Thakker; and
Mr Devesh Thacker
Benchmark Index Nifty 50 Arbitrage Index
Issue Opens January 30, 2019 Issue Closes February 13, 2019
(Source: Scheme Information Document)

How will the scheme allocate its assets?

Under normal circumstances, the Union Arbitrage Fund's asset allocation will be as under:

Table 2a: Asset Allocation under normal circumstances

Instruments Indicative Allocation (% of Total Assets) Risk Profile
Minimum Maximum High/Medium/Low
Equity and Equity related instruments (as part of hedged / arbitrage exposure) * 65% 90% Medium to High
Debt and Money Market Instruments including margin money deployed for derivatives transactions 10% 35% Low

*Equity allocation so built, at any point in time, would be completely hedged out, using derivative instruments that provide an equal but opposite exposure, thereby making the Net exposure market neutral. In case the fund is not able to have a net market-neutral position due to any operational reason such as short delivery in the cash market etc., the fund will endeavour to rebalance the portfolio to a net market-neutral position at the earliest.
Investment in Securitized Debt - Nil
Investments in Derivatives - upto 90% of the net assets of the scheme.
Investments in Securities Lending - upto 20% of its net assets of the scheme (where not more than 5% of the net assets of the scheme will be deployed in securities lending to any single counterparty).
The scheme does not intend to invest in overseas/foreign securities or participate in repo/ reverse repo transactions in corporate debt securities or engage in short selling or in Equity Linked Debentures or participate in credit default swap transactions.

(Source: Scheme Information Document)

Under defensive circumstances, the asset allocation of the United Arbitrage Fund will be as per the below table:

Table 2b: Asset Allocation under defensive circumstances

Instruments Indicative Allocation (% of Total Assets) Risk Profile
Minimum Maximum High/Medium/Low
Equity and Equity related instruments (as part of hedged / arbitrage exposure) * 0% 65% Medium to High
Debt and Money Market Instruments including margin money deployed for derivatives transactions 35% 100% Low

*Equity allocation so built, at any point in time, would be completely hedged out, using derivative instruments that provide an equal but opposite exposure, thereby making the Net exposure market neutral. In case the fund is not able to have a net market-neutral position due to any operational reason such as short delivery in the cash market etc., the fund will endeavour to rebalance the portfolio to a net market-neutral position at the earliest.
Defensive circumstances are when the arbitrage opportunities in the market place are negligible or returns through arbitrage opportunities are lower than alternative investment opportunities as per asset allocation pattern. The asset allocation under defensive considerations will be made keeping in view the interest of the unitholders.
Investment in Securitized Debt - Nil
Investments in Derivatives - upto 65% of the net assets of the scheme.
Investments in Securities Lending - upto 20% of its net assets of the scheme (where not more than 5% of the net assets of the scheme will be deployed in securities lending to any single counterparty).
The scheme does not intend to invest in overseas/foreign securities or participate in repo/ reverse repo transactions in corporate debt securities or engage in short selling or in Equity Linked Debentures or participate in credit default swap transactions.

(Source: Scheme Information Document)

What will be the Investment Strategy?

The Scheme will endeavour to invest in arbitrage opportunities between spot and futures prices of exchange-traded equities and the arbitrage opportunities available within the derivative segment as per the investment objective and the asset allocation pattern of the Scheme.

If suitable arbitrage opportunities are not available in the opinion of the Fund Manager, the scheme may predominantly invest in debt and money market securities. The objective of the strategy is to lock-in the arbitrage gains.

The fund manager will evaluate the difference between the price of a stock in the futures market and in the spot market. If the price of a stock in the futures market is higher than in the spot market, after adjusting for cost and taxes, the scheme may buy the stock in the spot market and sell the same stock in equal quantity in the futures market simultaneously.

The Scheme will endeavour to build similar market neutral positions that offer an arbitrage potential, for e.g. buying the basket of index constituents in the cash or futures segment and selling the index futures, etc. The Scheme would also look to avail of opportunities between one futures contract and another.

The fund manager shall use derivatives within the permissible limits actively in-addition to hedging and rebalancing the portfolio subject to the Regulations and the investment objectives and the terms of the scheme set out elsewhere in this Scheme Information Document.

The fund manager could also use active cash calls to rebalance or hedge the portfolio up to the permissible limits.

Further, the Scheme intends to use derivatives actively in-addition to the purpose of hedging and portfolio balancing or such other purpose as may be permitted under the Regulations from time to time.

Who will manage Union Arbitrage Fund?

Mr Vishal Thakker will manage the Equity portion of the scheme, while the debt portion will be managed by Mr Devesh Thacker.

Mr Vishal Thakker has to his credit a Master's in Finance Management (MFM) and over 8 years of experience in equity & derivative dealing functions.

Prior to his appointment as a Co-Fund Manager, he has been associated with Union Asset Management Company Private Limited as Dealer - Equity since March 2017. Prior to that, he was associated with Elara Capital as a Sales Trader for 7 years. He was also associated with Emkay Shares & Stock Broking as a Dealer from June for few months.

Mr Devesh Thacker has a bachelor's degree in commerce and an MBA to his credit. His overall work experience spans over 18 years in Fund Management & Banking Industry.

Before joining the Union Asset Management Company Pvt. Ltd. (AMC) as Fund Manager - Fixed Income, he was with Sahara Asset Management Co. Pvt. as Fund Manager - Fixed Income. Before that with ICICI Bank Limited, as a part of Retail Operations and Branch Banking, at Dolat Capital Markets Limited as a Dealer in Fixed Income, handling institutional client's deals and queries. At Orbis Securities (India Bulls) Limited, he worked as a Dealer in Fixed Income and at ASK Financial Services Ltd (NSE Broking Firm) as an Equity and Derivative Dealer.

At the fund house, Mr Devesh Thacker manages Union Liquid Fund, Union Dynamic Bond Fund and Union Short Term Fund.

The outlook for Union Arbitrage Fund.

Since UAF is skewed more towards equities, mainly with the objective of investing in arbitrage opportunities, the fortune of UAF will be closely linked to how astutely the fund manager cites these opportunities.

Tapping arbitrage opportunities is a challenging task, owing to the key risks associated with the arbitrage strategy:

  • Lack of opportunity available in the market
  • The risk of mispricing or improper valuation and the inability of derivatives to correlate perfectly with the underlying assets, rates and indices.
  • Execution Risk: The prices which are seen on the screen need not be the same at which execution will take place. This is because arbitrage opportunities are often short-lived.

Hence, the performance of the Union Arbitrage Fund depends on the construction of the portfolio using the arbitrage strategy. If there are fewer arbitrage opportunities, UAF would move into cash and money market instruments.

Thus, as an investor, before you invest in any arbitrage fund, you ought to recognise that arbitrage opportunities might not always work out. Since there's a 10% Long Term Capital Gains Tax (LTCG) on arbitrage funds for gains above Rs 1 lakh in a financial year, arbitrage funds have become unattractive for big-ticket investments.

[Read: How LTCG Tax On Equity Investments Can Derail Your Financial Plan]

So, before investing consider your investment objective, time horizon and risk appetite.

Editor's note: If you're unsure where to invest fresh investible surplus currently, to strike the correct risk-return trade-off we recommend adopt a 'core and satellite approach' to investing. Core and satellite' investing is a time-tested strategic way to structure and/or restructure your investment portfolio.

If you're looking for "high investment gains at relatively moderate risk" this ready-made portfolio would be suitable for you. The 2019 Edition of PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025"

In this report, PersonalFN will provide you with a ready-made portfolio of its top equity mutual funds schemes for 2025 that have the ability to generate lucrative returns over the long term.

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Author: Aditi Murkute

This article first appeared on PersonalFN here

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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