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Will my investments in arbitrage funds be safe if there is mass redemption?

These funds are not risky but consider diversifying your fixed-income investments, says Dhirendra Kumar

Arbitrage funds are the rage right now. How safe will my investments be if there is any mass redemption, with people moving to other fancy products? I want to avoid losses that arise just because I stayed while others panicked and bolted similar to what happened during the credit risk fund fiasco.
- Prashanth Balachandran

Yes, an investor can feel very foolish if he/she is the only one who gets caught, while everybody else walks away. The recent problem or the risk in fixed-income funds has come from investors' action rather than any credit event. The herd behaviour of investors, coupled with the over-competitive mutual fund industry where a lot of intermediaries and distributors drive investors to act in a hurry, has caused the crisis in fixed-income funds. And we have not been able to find a way around it. The exit load that we have in arbitrage funds is not good enough to prevent investors from redeeming their investments.

But I would say that arbitrage funds are reasonably safe by their design and I don't think they are completely vulnerable to investors' action. These funds do not take any credit risk rather they derive their returns from mispricing between the cash and derivatives market for equities. And these positions are marked to the market on a daily basis. These settlements are always guaranteed or backed by the stock exchange settlement mechanism. So, I do not think there is much of a risk there, but they can falter and the returns can be volatile and thus, can come down. Further, many a time, arbitrage opportunities are not there and then, these funds tend to become a liquid fund. So, I would say that they are not risky and you will not face any mass-redemption-type situation but spread your investments. I think that diversification is the only mechanism that we have to de-risk ourselves substantially.

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