Arbitrage Funds: Equity Taxation, Debt-Like Risk

An arbitrage fund simultaneously buys a stock in the cash market and sells its futures contract, locking in the price difference between the two. Because both positions offset, the fund is not taking a directional bet on the market.

Risk like debt, tax like equity

The hedged structure means volatility resembles a short-term debt fund. But because the fund holds equity and equity derivatives, it qualifies as equity-oriented for tax purposes — the combination that makes the category popular with investors in higher tax brackets.

Where the returns come from

Spreads are a function of market conditions, not manager skill in stock picking. Expect returns broadly in the neighbourhood of short-term debt, varying with volatility and rates.

Who they suit

• Parking money for a few months to a year in a higher tax bracket.
• Holding the debt-like portion of a portfolio more tax-efficiently.
• Not a substitute for equity growth, and not a guaranteed-return product.