The biggest lure of arbitrage funds earlier was the advantage of the price difference between cash and futures markets that they provided to generate returns. But, with the advent of computerised algorithmic trading tools, their sheen has gone off in the past few years. Computerised trading has considerably reduced the time required to take advantage of price anomalies between the cash and derivatives markets which has resulted in shrinking of arbitrage opportunities. As a result of this, arbitrage funds are now mostly investing in money market instruments, which has resulted in disappearance of the tax advantage these schemes previously had.
Also, investors have been fast to catch on opportunities in other categories such as income funds, short-term debt funds and liquid funds, which have generated higher returns in the short-term.
The numbers also show that the popularity of arbitrage funds is on a decline with assets managed going down from Rs 6,893 crore during the peak in November 2007 to just Rs 410 crore in November 2012. The number of schemes too has come down to 15 and these might also phase out owing to low investor interest. Recently, Goldman Sachs AMC wound up GS Derivatives and GS Equity and Derivatives Opportunities Fund, that were managing a combined Rs 7 crore.
Considering the inability to meet their desired objectives, investors would be better off to exit such funds.