SBI Arbitrage Opportunities Fund (SBI-AOF) is an open-ended equity oriented fund. The fund proposes to capitalise on the arbitrage opportunities arising out of mis-pricing of stocks in the equities and derivatives (Futures & Options) markets.
An arbitrage opportunity arises due to market inefficiencies, which in turn results in mis-pricing in prices of stocks or other instruments in two or more markets. SBI-AOF seeks to exploit such mis-pricing opportunities arising in equities and derivatives markets. In the absence of profitable arbitrage opportunities, the fund will hold its assets in debt and money market instruments.
Besides adopting the most commonly used arbitrage strategy of purchasing stocks in equity markets and simultaneously selling futures contract of the same stocks, SBI-AOF will use other complex strategies as permitted by SEBI (Security and Exchange Board of India).
An important feature of an arbitrage strategy is that it can act as a safeguard against market volatility as both the buying and selling legs offset each other. The returns in an arbitrage transaction are locked at the time of the transaction. In that respect, the fund offers a relatively low-risk investment option for investors.
Being an arbitrage fund, SBI-AOF relies exclusively on mis-pricing of securities in the cash and derivatives markets. There could be occasions when mis-pricing opportunities are rare and difficult to spot; it will require an active fund manager to spot these limited opportunities. Also simultaneous trades in different markets increase the transaction cost considerably; this could have an adverse impact on the returns of the fund.
How mutual funds use derivatives
Before investing in SBI-AOF or any other arbitrage fund, investors must know that despite investing in both, equity and derivatives market, these are not like conventional diversified equity funds. This is because the returns generated by these funds are based purely on mis-pricing (across markets) and not from investments in the cash market (which is how equity funds generate a return). Therefore, expectations of returns from arbitrage funds must be tempered.
The concept of using an arbitrage strategy in the domain of mutual funds is a relatively new concept and has not yet evolved completely. Also, in the context of SBI-AOF, some of the strategies used are very complex and difficult for investors to understand. Our advice to investors is to give arbitrage funds some time to evolve and review their performance over a period of time before investing in them.
