Title : Why are Arbitrage Funds better than Liquid Funds or Savings Account or Fixed Deposits?

Abhay : With current economic uncertainties, investors are looking for extreme safety. What are the options?

Sameer : Options are many. However, considering that we wish to keep money liquid at all times, and do not wish to have any interest risk or credit risk, I would name the following :

  1. Savings Account / Bank Flexi deposit account
  2. Overnight Funds & Liquid Funds, and
  3. Arbitrage Funds

Abhay : Depending upon my liquidity needs, what minimum period I should invest in each of the options that you mentioned?

Sameer : If you are investing for merely 1 day or 1 week…the Savings Account & Overnight funds should be your preferred choice. If you are investing for a month or two, then Bank Flexi deposits or Liquid Funds can be opted.
But, if you are investing for more than 3 months, then Arbitrage Funds should be your preferred option.

Abhay : How much return can we expect in each of the options ?

Sameer : As per the latest:

  • SBI Savings rate is around 2.75% p.a
  • Overnight Funds rate is around 3.50% p.a.
  • Liquid Funds are yielding in the range of 4.5% to 5.5%
  • SBI Flexi deposits are yielding 4.50%
  • Arbitrage Funds are yielding around 5% to 6%

Abhay : Is it the higher yield of Arbitrage Funds that you are suggesting it to be the preferred option for more than 3 months period?

Sameer : No. Actually, the Arbitrage Funds are more tax efficient than Savings Account or Fixed Deposit or Liquid Funds.
To understand it better, for an investor in 30% tax slab, post tax returns from Fixed deposit shall be 3.15%, where as Arbitrage Fund shall yield between 4.25% to 5.40%.

Abhay : What has been the long term performance of Arbitrage Funds?

Sameer : Over last 10 years, this category has caught the fancy of every sophisticated investor. Last 10 years average return has been 7.43% p.a. in this category.
But, because interest rates keep fluctuating, there have been years where this fund category yielded around 10% in a high interest year, and also around 5% in a low interest year.

Abhay : Has there been a year where the return was less than ZERO…or say negative return?

Sameer : Not a single year, although in case of extreme rare circumstance, the NAV can be negative for a month or two.
That’s why I say that we should not invest for period less than 3 months. This happens when there are extreme fluctuations in the equity and derivative market.
However, the investment gets rewarded the very next month with surplus performance. So, it is a volatility of 1 to 2 months at max.

Abhay : For investors in lower tax slabs …like 10% or 20%, would you advise Arbitrage Funds for them as well..?

Sameer : I think they can consider liquid funds or short term funds. Actually, the tax advantage of Arbitrage Funds fades in their case.

Abhay : Is there any other advantage or disadvantage of Arbitrage Funds over Fixed Deposit or Liquid Funds?

Sameer : I think advantages I have told you !
There is one disadvantage. If you exit from Liquid Fund or Fixed Deposit, the money gets credited to your account in one Day. Whereas, if you withdraw from an Arbitrage Fund, it will take 3 working days to receive the amount.


By Sameer Rastogi

18 years of experience, PG in Finance and has delivered Wealth Management lectures at IIM Lucknow, IBS Gurgaon and IIPM Delhi. Contributed to various newspapers. Strength – Application of Economic fundamentals to Investment

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