Mutual fund investments are associated with market uncertainties. Equity funds offer high returns but are also associated with the risk of losses during market volatility. To safeguard investments during such situations, effective strategies are essential to follow. A blend is typically offered through Debt + Arbitrage Fund of Funds (FoFs).

But how do they make a difference and help protect the investments? The answer lies in understanding the debt and arbitrage fund meaning and other relevant details. Explore the same here to get into making informed decisions.

What is Debt Fund?

Debt funds are invested in securities capable of offering steady returns. Though the returns are low, they come with reduced risk. Debt funds invest in corporate bonds, treasury bills, government securities, commercial papers and other market instruments. These investments are also referred to as bond funds or fixed income funds. Debt funds offer comparatively high liquidity and safety with a low-cost structure.

Features of Debt Mutual Funds

The characteristics of debt mutual funds are as follows:

• They offer relatively stable returns at low risk

• The returns are lower than those of equity funds

• They are suitable for both short and medium-term investment goals

• They offer better liquidity than traditional fixed deposits

• They can be used to obtain a regular source of income

What is Arbitrage Fund?

These funds are hybrid mutual funds with a goal to create returns by exploiting the price differences of the same security in different markets. These markets include the cash market and derivatives market. The fund manager buys a security in the cash market and simultaneously sells the same in the future market, when there is a profitable price difference.

These funds use the strategy repeatedly to earn moderate and steady returns with relatively low risk, typically in volatile markets.

Features of Arbitrage Mutual Funds

The characteristics of arbitrage mutual funds are as follows:

• They are equity-oriented funds

• These are low-risk investments offering safety during market fluctuations

• They offer better post-tax returns in comparison to regular debt or non-equity funds

• Returns depend on market arbitrage opportunities

• They leverage short-term opportunities

Why Debt + Arbitrage Fund of Funds?

In a Debt + Arbitrage Fund of Funds, your money is not directly invested into market securities. Instead, the FoF invests in a mix of underlying debt mutual funds and arbitrage mutual funds. This structure allows investors to gain the benefit of diversification, professional fund management, and dynamic allocation between fixed-income and arbitrage strategies, all within a single fund.

For instance, the Aditya Birla Sun Life Arbitrage Fund aims to generate income by capitalising on price differences in stocks and indices across various market segments. It primarily invests in equity and equity-related instruments, while also allocating a portion to debt and money market securities.

This structure helps balance risk and return, making it a suitable option for investors seeking stability during volatile markets.

How Debt + Arbitrage FoFs Tackle Market Volatility

Market volatility refers to the fluctuations in an asset’s prices. The fluctuation involves both ups and downs in the prices, which have consequences on returns from investments. Both debt and arbitrage funds can reduce the impact of market volatility. Here is how:

Debt Funds

• Stability: Debt funds are less affected by market volatility. Thus, they offer protection against sharp market falls, decreasing the overall risk associated with the investment portfolio.

• Risk balance: In scenarios of investment in hybrid funds involving both equity and debt, the equities exhibit high volatility. Balancing the same is possible with debts, which offer protection against losses.

• Fulfil short-term goals: Debt funds are also a better option to meet short-term financial goals due to their high flexibility and liquidity. The debt funds also offer access to funds during market downturns when redeeming equity investments could result in losses.

• Regular income source: Debt funds are a source of regular income as well, by opting for dividend or systematic withdrawals.

Arbitrage Funds

• Leverage high price differences: The high market fluctuations often amplify price inefficiencies. These price gaps between cash and future markets are leveraged by arbitrage funds to lock in small and relatively low-risk profits.

• Short-term gains: The arbitrage funds work based on the short-term trading of temporary price discrepancies. The change in prices is immediately used to gain benefits, which helps generate steady returns even in volatile market conditions.

• Diversified strategies for low risk: The lower correlation in the performance of the assets in volatile phases creates more opportunities for arbitrage. Here, the funds are allocated across different arbitrage strategies such as cash-futures arbitrage, convertible arbitrage or merger arbitrage. This diversification reduces concentration risk and supports steady performance.

Wrapping Up!

Debt and arbitrage funds follow different investment approaches but share a common goal: to deliver stability during uncertain market conditions. A Debt + Arbitrage FoF smartly combines these two for better risk-adjusted returns. Thus, it is a suitable option for conservative to moderate investors.
The two work through different approaches to offer a common result, i.e., protection of investments from market fluctuations. The combination of the two can help develop a portfolio capable of handling market swings without compromising on growth potential.

Sources:

• https://www.mutualfundssahihai.com/en/what-are-debt-funds

• https://groww.in/mutual-funds/debt-funds

• https://www.bajajamc.com/knowledge-centre/how-arbitrage-funds-leverage-market-volatility

• https://brandstories.livemint.com/winning-over-volatility/how_debt_funds_can_reduce_the_impact_of_market_corrections_on_your_portfolio.html

• https://groww.in/mutual-funds/hybrid-funds/arbitrage-funds

• https://www.bankoncube.com/post/arbitrage-funds-important-things-to-know?0cc03a8e_page=2

The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.