Bears vs. Bulls ... the eternal battle

As the Sensex rallied from below 3,000 to over 12,500 in just about three years, you were probably pampered into believing that making money in the stock market was easy.

But the sliding market of the last six weeks and the accompanying daily swings in stock prices have made us realise that shares are risky instruments to play with.

And volatility could cut both ways—that is, if you don’t know how to ride the wave.

There’s a breed among marketmen that specialises in profiting from such volatility and also from mis-pricing in the market—when inexperienced investors fail to decide about the price of a stock in the regular segment (that is, the cash segment) and the price of the same stock in the derivatives segment.

In market parlance this breed is called the arbitragers and the process, arbitrage: buy where the price of a stock is lower and sell the same in the other segment, since there the price is higher.

The buying and selling has to be done simultaneously, and without any delay in trade. And since there’s no delay between the two trades, the risk of any loss of money is also nearly zero. But hang on! This is no more the exclusive domain of specialists.

To let retail investors profit from such specialised processes, mutual funds have started launching schemes, termed arbitrage funds. Before we explain the advantages of investing in arbitrage funds, here’s a short take on how the trades are done.

Suppose, the price of stock A in the cash segment is Rs 99 and the price of the futures on stock A in the derivatives segment is Rs 100. The fund manager would buy the stock at Rs 99 and sell the futures at Rs 100, at the same time. Thus making a profit of Re 1, without any risk. There’s no chance of capital erosion as the trades are fully hedged.

“Usually returns in arbitrage funds are higher than most fixed income investments like liquid funds, monthly income plans, 8% RBI bonds, bank fixed deposits etc.” said Biren Mehta, fund manager, JM Arbitrage Advantage Fund, that would close for subscription on Friday, June 30. “These funds do not carry any interest rate risk.

They do not carry any credit rating risk either,” Mehta said. In addition, “investors also enjoy the tax efficiency of equity funds,” said Sundeep Patel, fund manager, UTI Spread Fund, UTIMF's arbitrage fund that closed its NFO on Thursday and would open for regular transactions soon.

Despite choppy market conditions, UTIMF collected about Rs 400 crore in this fund. Fund managers admit that in a sliding market it was tougher to make money even in arbitrage funds than in a bullish market. “But then think about this: Even in a bad market we make money.

When the market is sliding you could even get 4-6% risk-free-tax-free return while other equity funds lose money. In a good market we make 14-16%.

That too without risk and and taxes,'' a fund manager said. With an arbitrage fund, one can get 4-6% risk-free-tax-free return even when the market is sliding, while other equity funds lose money arbitrage funds take advantage of the price difference for the same stock in the cash segment and the derivatives segment.

The buying and selling has to be done simultaneously, and without any delay in trade. Since there’s no delay between the two trades, the risk of loss is nearly zero lUsually returns in arbitrage funds are higher than most fixed income investments. These funds do not carry any interest rate risk or credit rating risk either