UTI Spread Fund (UTISF) is an open-ended equity-oriented fund and one of the two arbitrage funds to be launched this month (the other fund being JM Arbitrage Advantage Fund). Like other arbitrage funds, UTISF will also try to exploit the opportunities arising out of mis-pricing in the cash and derivatives markets.
Also read: Our NFO coverage on JM Arbitrage Fund
UTISF will enter into simultaneous transactions of buying a stock in the cash market and selling the same stock in the futures market. This kind of arbitrage opportunity arises when the prices in futures market are higher than that in the cash market. Ideally, the positions are held till the expiry of the futures contract, but there could also be instances of unwinding both the positions before the expiry of the current-month future to increase the base return or to meet redemption. With this arbitrage strategy, equity position is completely hedged at the beginning, making the fund a low risk investment proposition; and also making it less susceptible to market volatility.
Another type of arbitrage strategy arises when the futures price is quoting at a discount to the cash market. In such a scenario, the futures contract will be bought and shares will be sold to make arbitrage profit. This type of arbitrage strategy is called reverse arbitrage. This strategy involves selling of shares, which the fund does not own and would lead to short selling. Mutual funds at present are not allowed to short sell. UTISF has the option to enter into reverse arbitrage and may practice it as soon as they get the nod from SEBI (Securities and Exchange Board of India). Apart from this, the fund also has the option to practice other arbitrage strategies like Index Arbitrage (buy Nifty Spot and sell Nifty Futures) and buy call option.
With the option of selling in cash and buying in futures being retained by UTISF (though short selling in cash market by mutual fund is not currently allowed by the regulator), this could become a risky proposition for investors. This option will make the arbitrage transaction an intraday proposition wherein the fund will have to buy the shares (after shorting them) on the same day to make delivery to the exchange. Failure to do so would lead to penalty being imposed by the Exchange for short selling. However, as mentioned earlier, SEBI has to yet give the go-ahead for short-selling.
UTISF also proposes to buy call options. The risk of investing in options is that, the views of the fund manager about the market may not materialise and the fund may loose the entire premium paid for taking position in options.
Though UTISF offers investors the opportunity to benefit from investments in equities by making use of derivatives, the fund cannot be compared to conventional diversified equity funds, especially on the returns parameter. The returns from arbitrage funds would typically be much lower than those of equity funds (over a 3-Yr investment horizon). Thus UTISF could find a place in the mutual fund portfolio of risk-averse investors. However, investing in the fund could become a riskier proposition, if and when the fund is permitted to short-sell in the cash market.
