Real estate ventures and mutual funds

Funds are thriving and fund action continues unabated in India’s booming real estate market. TSI Ventures, an equal joint venture between Tishman Speyer and ICICI Ventures, has mopped up over $1-billion, barely 15-months after it was floated.

This, while there are even more mega funds in Indian real estate’s pipeline. We have Actis looking at an India specific realty fund, and US-based Apollo Real Estate Advisors teaming up with Sun Group, just so they can pump in investments into the domestic real estate sector, a market which is probably, throwing up better yields than its peers amongst the emerging markets.

TSI Ventures multiple closing fund, which came into existence with $500-600 million, is currently seen to be crossing $1-billion, according to sources in the know. TSI, focussing on from the ground up projects, recently closed its first $100-million investment for 1.5-million sq. ft. project in Hyderabad. The fund is now closing in on deals in Bangalore, Chennai and Pune, one of which is a large integrated township.

Prakash Gurbaxani, CEO of TSI Ventures says his firm hopes to be managing and operating between 25,000 and 30,000-million sq. ft. space, both residential and commercial, over the next five to seven years. This could make it one of the largest real estate asset management entities in the country, as it targets a figure far bigger, than some of India’s largest realty houses have come up with, to date.

Meanwhile, UK-based private equity major Acentis bullish on the consumer products space, is exploring the possibility of an India-specific real estate fund. This fund could look at pure play realty, hospitality and tourism sectors. Currently, Actis operating the $500-million India specific fund, made investments and effected buyouts in the consumer products and services domain.

Last week, US realty major Apollo Real Estate Advisors forged a joint venture with Khemkas controlled Sun Group for its India foray with a $500-600-million fund, which could show up as nearly $1.5-billion in the future.

A group of former Morgan Stanley executives has floated $500-million India fund, Old Lane, for the infrastructure sector, which would also look at financing commercial real estate projects. The others exploring the domestic real estate action include London-based $300-million Duke India and a $100-million Saffron fund. The industry experts are hinting at cross-border fund flows of roughly $4-5-billion into the country over the next 12-18 months.

While, the fund action in realty is expected to gather momentum, with about 50-60 new ones India bound, questions are being raised on the investment avenues available in the country. Industry observers’ note, publicly listed realty stocks are far fewer in India compared to China and Hong Kong, even though the domestic market is better placed in terms of transparency.

That is nothing to get into a tizzy about, just as the Indian real estate market gains greater transparency, publicly listed realty stocks may soon match China’s and Hong Kong’s. Indian realty is the best bet for your bottom dollar!

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Best performance of Index Funds

In terms of fund management, mutual funds can be broadly classified into two categories: actively managed funds and passively managed -- better known as index funds. In an actively managed fund, the fund manager uses his expertise and skills to select stocks across sectors and market segments.

The sole intention of actively managed funds is to identify the best investment opportunities and exploit it in order to generate superior returns, and in the process outperform the benchmark index.

On the contrary, index funds are aligned to a particular benchmark index like the Nifty or Sensex. They attempt to mirror the performance of the designated benchmark index, by investing only in the stocks of the index with the corresponding allocations.

In developed economies like the United States for instance, index funds are very popular among mutual fund investors and are preferred over actively managed funds. This is because of the clear advantages they offer to investors, like no loads and lower expenses among others.

Moreover, in the United States, stock markets are more efficient, so investment opportunities are at a premium. They are relatively difficult to identify, because widely disseminated research makes just about everyone aware of these opportunities, so this blunts the first mover advantage.

As a result, a number of actively managed funds in developed economies fail to outperform the broader stock market indices thereby pushing the cause of index funds.

Investing in index funds is relatively less cumbersome. Here, the two most important points which investors have to look out for are the expense ratio and the tracking error (i.e., the difference between the returns clocked by the benchmark index and index funds).

Thus, unlike actively managed funds, index fund investors can forgo other aspects of investing such as fund house's investment philosophy and the kind of funds to choose -- a large cap/mid cap/small cap fund.

On the other hand, investors investing in actively managed funds have to assess all the above-mentioned criteria and more before investing. These funds have to capitalise on the opportunities in the market to generate superior returns. Thus, in the process they employ more resources (more analysts/fund managers) and in turn charge higher expenses than index funds.

In the Indian context, the mutual funds segment is dominated by actively managed funds. Index funds occupy a much smaller share of the market.

This is because Indian stock markets, being in a developing phase, still offer enough investment opportunities that if identified earlier on can outperform the benchmark index over the long-term (3-5 years). So well-managed actively managed funds have done a reasonable job of going one up over the index over the long-term.

We did a brief study wherein we faced-off the average category returns of index funds (passively managed) vis-�-vis those of diversified equity funds (actively managed). In a way, the results are on predictable lines.

Active Funds: Long-term bets

Categories	Average category returns
	1-year (%)	3-year (%)	5-year (%)
Index funds	55.5	35.0	32.7
Diversified equity funds	40.4	42.6	45.3

(Returns as on October 16, 2006)

On comparing the category average returns of active funds and passive funds over varying time frames, one can conclude that it's something of a mixed bag, with each category performing well only over a certain time frame.

For instance, over 1-year, index funds (55.5%) are ahead of diversified equity funds (40.4%). However, extend this time frame to 3-year and even 5-year, and the scenario changes completely. Gone is the sheer domination of index funds over active funds.

Over 3-year, diversified equity funds (42.6%) have comprehensively outperformed index funds (35.0%) by 7.6%, and this gap further widens to 12.6 % over 5-year.

In a nutshell, even in the Indian context, index funds offer advantages like lower expenses (although they aren't quite as low as they should be compared to US Index Funds) and lower volatility in performance as compared to actively managed funds.

They can also outperform actively managed funds although usually only over shorter time frames (less than 3 years). But over longer time frames of 3-5 years (which is ideal for evaluating equity-oriented funds), actively managed funds more than hold their own against index funds.

Hence, for risk-taking investors, actively managed funds should occupy a larger share of the portfolio. Index funds can also occupy a smaller share, mainly from a diversification perspective.

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Review of Franklin Templeton Capital Safety Fund (FTCSF)

Franklin Templeton Investments (India) has launched Franklin Templeton Capital Safety Fund (FTCSF), the first of the many 'Capital Guaranteed' schemes slated to hit the markets soon.

The scheme endeavors to protect the capital by investing in high quality fixed income securities as the primary objective and generate capital appreciation by investing in equity and equity related instruments as a secondary objective. Franklin Templeton launches Capital Safety Fund)

Offer opens: October 31, 2006 Offer closes: November 30, 2006 Entry load: Nil Exit load: Nil Minimum investment: Rs 10,000 Type of fund: Close-ended Tenure: 3-years and 5-years Benchmark: Crisil MIP Blended Index Fund Managers: Santosh Kamath (debt) and Satish Ramanathan (equity)

Franklin Templeton Capital Safety Fund offers a 3-year and a 5-year plan. Being a close-ended fund, the fund will not repurchase units of the scheme before the end of the maturity period. (Check out - New Fund Offers open now)

Experts believe that though such schemes offer the investor the opportunity to have his cake and eat it too, investors should note that this doesn't come without having to make some compromise.

1) Limited Equity Upside

“In Franklin Templeton Capital Safety Fund, capital guarantee would mean a minimum of 70% of the funds invested in fixed income securities for the 3 year plan and a minimum of 80% of the funds invested in fixed income for the five year plan. Therefore, equity upside, if any, would be limited to the 20% and the 30% portion invested in equity respectively”, says investment expert Sandeep Shanbhag.

However, Sukumar Rajah, CIO - Equity, Franklin Templeton clarifies that, “FTCSF allocates a major proportion of its portfolio to high quality debt investments in order to protect capital and the remainder is in equities so that investors can benefit from the upside potential of Indian equities over the long term.” “Investors comfortable with the near term volatility and looking for potentially higher returns should look to invest in well-managed diversified equity funds with an established track record over market cycles”, he added.

2) Capital Protection is NOT Guaranteed
 
The fund house, per se, does not guarantee that the capital will be protected. Instead what the capital guarantee means is that CRISIL has assigned a rating to the scheme that signifies a high degree of certainty regarding timely repayment of the face value of the investment.
 
Sukumar agrees as he says that regulations do not permit mutual funds to offer any “guarantee” pertaining to returns or safety of capital on their products. However, he assures that the portfolio structure of FTCSF is designed in such a way that investors are likely to get Rs.100 back for every Rs.100 invested.

He clarifies, “The chances of an erosion of capital are low given the structure of portfolio. The ability of this fund’s portfolio structure to deliver capital protection is also affirmed by CRISIL through an AAA (SO) rating, which indicates “a high degree of certainty regarding the timely repayment of principal”. Debt investments will be in AAA or equivalent securities that match the maturity profile of the fund, minimizing both credit & interest rate risk. The chances of a capital erosion from the debt portfolio are minimal given the near-zero default ratio for AAA rated securities by CRISIL.” 

”The portfolio allocation is determined in such a way so as to provide enough cushion to mitigate credit, reinvestment, float and liquidity risks along with transactions costs. In addition, the portfolio will be monitored by the rating agency on a monthly basis to determine the probability of the portfolio value falling below the original principal value and this would necessitate any changes to the portfolio. As part of the investment process, we will be closely monitoring the credit quality of our investments and would proactively shift investments into good quality papers, if we sense a change in the issuers’ fundamentals”, he added.

3) Liquidity – A Concern?
 
Current Sebi regulations do not allow a fund house launching a capital protection scheme to provide for an exit window to the investors. “Though the fund is planning to get the fund listed on the NSE in an attempt to offer some exit option, it'll not be the same as having the facility of redeeming units directly with the fund house”, said advisor Hemant Rustagi.

Sukumar counters as he says, “This fund is not meant as an alternative to equity investments, it is positioned as an attractive alternative for conservative investors used to parking their long term money in traditional fixed income avenues, where there is a chance of getting low inflation-adjusted returns.”

Conclusion:
 
All said, experts believe that FTCSF would prove to be a good investment for the risk averse investor who doesn't mind compromising on his returns for the additional implied safety. 

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Future investment for your child through Mutual funds

All of us want our children to get the best education possible. By having a financial plan in place, you can make it possible for your child to have better options, both in terms of deciding the type of education as well as selection of colleges.

To achieve this very important goal of your life, investing early is a very simple yet powerful method. The earlier you start, the longer your investments have time to grow.

There are many who do not consider it necessary to start investing for their child's education when he or she is in pre-school. However, the fact is that investing early ensures that there are no short falls in the targeted amounts.

Besides, since building up assets for your child's education is a long term objective, it is important to ensure that you invest in those options that have the potential to give you better real rate of return i.e. returns minus inflation. This factor is crucial considering the escalating costs of higher education.

Remember, the way you save as well your investment strategy will depend on many factors like how much you wish to save, how long until the money is needed, and whether you have a lump sum or will be saving out of your current income.

Mutual funds can provide an excellent investment vehicle for your child's education. They offer diversification, flexibility and simplicity. Besides, investing through a tax efficient vehicle like mutual funds can help you accumulate more for your child's education.

Depending upon when you begin investing for your child, here are some model portfolios:

1. Age of the child: Newborn to 5 years

• Investment horizon : 13 to 18 years

If you start investing at this stage, you allow your savings the maximum time to build up assets for your child's education. With time on your side, you can take higher risk and go for equity funds. However, if you choose to invest on a regular basis, try and increase the amount every year.

2. Age of the child: 6-12 years

• Investment horizon: 6 to 12 years

While a part of the portfolio may still focus on aggressive investment options like equity funds, you will do well to include balanced funds also to reduce risk. The attempt should be to move money to lesser volatile investment options, as the child grows older.

3. Age of the child: 13- 18 years

• Investment horizon: 1 to 5 years

At this stage, it would be advisable to invest in funds that are least volatile and overall the focus should be on preserving capital. Also, liquidity should be an important consideration while working out the strategy. While the open-ended mutual funds will ensure that the money is available to you as and when you require it, the key is to make the money grow at a reasonable rate.

As mentioned earlier, for those who wish to take the equity fund route and invest on a regular basis, a Systematic Investment Plan (SIP) is the best. It is a proven fact that a steady plan both in terms of savings and investments helps pursue financial goals.

What SIP really means is that you invest a fixed sum every month. When you invest a fixed amount, such as Rs 5000 a month, you buy fewer units when the share prices are high, and more units when the share prices are low.

Besides, you take advantage of the fact that over a period of time stock markets generally go up, so your average cost price tends to fall below the average NAV. This 'averaging' ensures that you buy at different levels, without having to worry about the market levels.

Here are some important points to remember before you establish your regular investment programme:

• Decide how much you want to invest on a regular basis. It is important to choose an amount that you will be comfortable investing regularly over the long term.
• Decide the frequency at which you want to invest-each month or each quarter.
• Continue investing irrespective of whether the market falls or rises.
• Remember the objective for which you are investing throughout the period. This will enable you to remain focused on this very important goal of your life.

For those who may not want to invest the entire money in equity funds, there are certain other options. Some of the mutual funds have established dedicated balanced funds for children, where in one has the option of investing in a ready made equity-oriented or a debt-oriented fund. Here is a glimpse of what these funds have offered to investors over a period of time.

Absolute Returns (in %) as on November 13, 2006
Hybrid: Equity-oriented
Scheme	1 Year	2 Years	3 Years	5 Years
HDFC Childrens Gift Fund (Inv Plan)	19.1	65.1	95.5	210.5
Principal Child Benefit - Career Builder	45.2	90.6	124.0	255.2
Principal Child Benefit - Future Guard	45.2	90.5	124.0	254.7
Pru ICICI Child Care Plan - Gift Plan	33.3	77.4	125.0	293.3
Hybrid: Debt-oriented
Scheme	1 Year	2 Years	3 Years	5 Years
HDFC Childrens Gift Fund (Sav Plan)	3.9	22.1	32.5	77.4
Pru ICICI Child Care Plan - Study Plan	15.0	30.3	40.7	89.5
Magnum Childrens Benefit Plan	12.0	26.3	32.7	--
LIC MF Childrens Fund	15.8	19.0	23.0	47.8
Tata Young Citizens Fund	27.4	58.6	82.6	191.8
Templeton (I) Childrens Asset - Gift Plan	37.0	47.4	54.5	93.0

(Past performance is no guarantee of future performance)

So, go ahead and start planning for your child today. Mutual funds have the right options to suit your requirements and the ability to help you realize your dreams.

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Review of HSBC Equity fund

 HSBC Equity was the first fund launched by the fund house in ’02. It follows a large-cap strategy. Over 85% of the fund’s portfolio consists of large-cap stocks. The fund has maintained a low-risk portfolio, while giving above-average returns in the diversified equity category. It got a Gold rating as per the latest ET Quarterly MF Tracker, based on risk-adjusted returns.

Since its launch, the fund has given a return of 62.1% per annum. ’05 was not a good year for the fund, with some of its stock calls backfiring. There are also concerns regarding stability of the management team, as fund managers keep changing.

To deal with this issue, the fund has brought in twin managers to ensure that even if one quits, the other keeps the boat afloat. Since June ’06, Mihir Vora and Jitendra Sriram have been managing the fund. If the three-month returns are any indication, the new managers seem to have brought stability to the fund.

Performance:

The fund’s three-month returns have beaten both the Sensex and its benchmark BSE 200, with returns of 18.9%. The fund’s higher exposure to IT services, telecom and automobile sectors have worked well, and so have low exposure to consumer durables and metal stocks. In the one-year period, the scheme gave a return of 48%. Though the fund’s returns are better than its benchmark and category average, it underperformed the Sensex by a margin of 10 percentage points.

’05 was bad for the fund as its exposures in oil and gas, commodities and banking stocks backfired. During mid-’05, the fund was underweight on capital goods and FMCG, which led the market rally. This affected the fund’s returns. But the three-year returns look better — the fund outperformed the Sensex by a large margin, and also bettered its category average over the three-year period.

Fund Management:

Since the beginning of this year, there has been a lot of churning in the fund management, as Anup Maheswari quit to join DSP Merrill Lynch. Viresh Mehta, who took over from him, quit in June ’06. Since then, Mihir Vora and Jitendra Sriram have taken over the fund. The new managers have made significant changes like exiting HCL Technologies in June ’06. Exposure to Bharti Airtel and RCL was increased. 

Portfolio:

The fund’s portfolio is tech-heavy. IT and telecom stocks together account for 27% of net assets. While IT stocks led by Infosys account for 19% of allocation, telecom services account for 7.7%. In the past four months, the fund has increased its exposure to Infosys from 6.3% at the end of June to 8.6% in October ’06.

The other addition to its portfolio is banking stocks. From just under 5% in June ’06, the fund’s banking exposure has increased to 10.9%. The fund prefers PSU banks; PNB leads the pack with 3.7% allocation. The fund has exited ICICI Bank and bought BoI India and SBI. The fund prefers four-wheeler companies. It has 11% allocation in M&M, Maruti and Tata Motors.

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Comparison of investing in ULIPs and Mutual Funds

 So you have heard umpteen numbers of times from your agent the same old Ulip song — this is one instrument which will give you insurance and help you achieve your investment goals as well. In doing so, he does everything to talk you out of investing in mutual funds (MFs) and also throws in his favourite sales pitch for good measure — you have to pay premium only for three years!

But nothing can be far from the truth — and we have numbers to substantiate this. Suppose you are 25 years old and wish to get insured, as well as plan investments. All is well till you call one of the financial planners — who are supposed to give you the best financial plan. But since you are ignorant — they do suggest a plan, which will be in their best interests.

If you tell him that you have the capacity to invest Rs 10,000 annually, he will immediately suggest that you go for a Ulip, whereby, in Rs 10,000, you will get a cover of Rs 2 lakh and some units as per the prevailing NAV, which will appreciate in value over time as the India growth story is intact.

Then he will show a chart of how the units have appreciated over the past three years with annual returns over 35-40%. He will tell you if you feel the market is going down, you can switch from equity-heavy investments to a debt-heavy one. By now, you are almost jumping out of your chair to sign the cheque. And then comes the best part — Sir, you need not invest for 20 years, even if you invest for only three years and then stop paying premiums, your policy will not lapse.

For the uninitiated, words such as 35% annual returns and only three years of premium-paying facility are enough to get you bowled over. Here is where you should ask the following questions: At 25, I am earning close to Rs 2.4 lakh per annum. By the time I near retirement, after 25-35 years, my salary will be at least Rs 12 lakh.

I am promised a princely sum of Rs 2 lakh as insurance! What if something were to happen to me at the prime of my life — will Rs 2 lakh be sufficient to take care of my family? A more focussed question will be — where does my money get invested? Do I get to see the portfolio as in MFs (although MFs have to declare their portfolios monthly, how many of us look at it)?  Moreover, since you do not understand about equity or debt markets — what is the use of your having the option of switching from equity-heavy investments to a debt-heavy one or vice versa?

If you were to opt for Ulip, then this is how your Rs 10,000 will be channelised in the first year. Around Rs 2,000 will go towards various expenses and your insurance (Rs 2 lakh) and the remaining Rs 8,000 is the amount which is actually invested.

Let’s see what happens if you decide to reject the option of this readily ‘available arranged marriage’. If you decide to split the sum of Rs 10,000 in two parts by buying a term policy for Rs 2,000 and investing Rs 8,000 in MFs you will be better off.

For Rs 2,000, you will get an insurance cover for Rs 8 lakh for 25 years. If you were to invest Rs 8,000 in an equity diversified fund (after paying the initial charge of 2%), the actual amount invested will be Rs 7,800 and you get the benefit of knowing the portfolio on a monthly basis.

Then why does your advisor want you to buy Ulips? The answer lies in the commissions. If you were to buy a Ulip for Rs 10,000 he will get Rs 750 as commission in the first year. But if you were to buy a term policy of Rs 2,000 — he will get Rs 500 as premium in the first year.

On your investment of Rs 8,000 in MFs, he will get around Rs 160 in the first year as commission. Hence, the total commission he will earn, if you were to go for a combination of term policy and MFs, will be Rs 500 + 160 = Rs 660, which is less than Rs 750!

Let’s see what happens from the second year onwards. The Ulip will fetch him Rs 200 per annum, whereas the combination of term insurance and MF will yield him Rs 150 and Rs 40, respectively, i.e. Rs 190, which again is less than a Ulip. In a nutshell, it’s always better to do some research before taking your planner’s advice at face value.

Your primary objective of getting the highest insurance at the cheapest price and also that of a sound investment is not his top priority — he will always look at his commissions. And as long as you are ignorant, he will continue to achieve his objective — whether you achieve yours or not!

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Investing in best diversified equity fund

When it comes to making investments in mutual funds, it all boils down to which fund to invest in. There is no dearth of choices, but then not all the options available merit consideration. There are 30 asset management companies currently in the mutual fund industry, and many more lining up for launches.

The variety of schemes offered by these AMCs is enormous. So it can be a challenge for the investor when it comes down to identifying a handful of mutual fund schemes from this rather large universe. The good news for the investor is that based on performance, most of these schemes fall short of making the grade. Thus the real challenge lies in finding those few schemes that do make the grade.

Often when it comes to evaluating their investment decisions, investors appear confused. The simplest of decisions proves elusive to them. This confusion is further enhanced by misrepresentation made by 'commission-hungry' mutual fund agents.

With so many forces working against them, it's essential for investors to have a set of objective parameters based on which the performance of mutual fund schemes can be evaluated. These parameters should serve as benchmarks for investors while selecting funds for their portfolios. We present a 4-step strategy for selecting the right diversified equity fund.

Compare returns across funds within the same category
One of the most basic forms of benchmarking involves comparing funds within a category. For instance, if you are evaluating Franklin India Bluechip Fund for investment, you should compare its returns with other predominantly large cap diversified equity funds. Comparing it with mid cap funds for example, will deliver erroneous results, because the risk-reward relationship between mid cap and large cap funds are not comparable.

As equities are best equipped to deliver returns over longer time frames (3-5 years), investments in diversified equity funds should be made with a long-term perspective. Hence, while comparing returns, investors must consider longer time frames (of 3-5 years) before taking a conclusive decision about investing in a fund. Comparing a fund over a longer time frame will also give investors a good idea about how the fund has fared over a stock market cycle (boom and bust).

Compare returns against those of the benchmark index
Regulations demand that every fund mentions a benchmark index in the Offer Document. The benchmark index serves the dual purpose of being a guidepost for both the fund manager and the investing community. All eyes must be on the benchmark index and how the fund has fared against it.

Again with an equity fund, investors should consider the performance of the fund over the longer time frame, while comparing it to its benchmark index. In the Indian context, most equity funds outperform their benchmark indices over the long-term (3-5 years).

However, during market turbulence, like the one witnessed over May-June this year, investors will find many equity funds trailing their benchmark indices. This is something we have observed on more than one occasion. The funds that can outperform their benchmark indices during stock market volatility must be marked closely.

Compare against the fund's own performance
Besides comparing a fund with its peers and benchmark index, investors should evaluate its historical performance. Not all funds show stability in performance over the years. Many of them slip up; only a few manage to sustain the good work they have done year after year, market cycle after market cycle.

By evaluating a fund against its own historical performance, you ensure that you get the most consistent performers in your mutual fund portfolio. The inconsistent performers (the one rally wonders) are available a dime a dozen and must be filtered effectively.

Risk-related parameters
While NAV returns are important, one area, which should never be ignored by investors is the risk taken on by the fund. Mutual funds being market-linked, are prime candidates for stock market related risks. The two aspects that investors should take into account are volatility of the fund as indicated by the Standard Deviation and risk-adjusted returns as calculated by the Sharpe Ratio.

While SD shows the degree of risk taken on by the fund, SR shows the return generated by the fund per unit of risk taken. The SD (volatility) of a fund should be lower than its peers; on the other hand, the SR should be higher.

The best fund is the one with the lowest SD and the highest SR within its peer group. Again, it is advisable for investors to evaluate the SD and SR of the fund on a historical basis so as to identify the most consistent performers.

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Invest in Derivative Arbitrage funds

Banks, sweating to mop-up their deposits from conservative investors, have a new adversary. In addition to capital protected funds and fixed maturity plans (FMPs), mutual funds are now lining up derivatives arbitrage funds.

Typically, these funds promise safety of deposits, but claim to provide better returns, tax benefits and greater liquidity. Pru ICICI is the latest to join the list with its equities and derivatives fund.

The open-ended equity scheme aims to generate low volatility returns by investing in a mix of cash equities, equity derivatives and debt markets. The fund seeks to provide better returns than typical debt instruments and lower volatility in comparison to equity.

As Nilesh Shah, CIO, Pru ICICI, and fund manager explains, “This fund is aimed at an investor who seeks the returns of small-savings instruments, safety of bank deposits, tax benefits of RBI Relief Bonds and liquidity of a mutual fund.”
Pru ICICI already has two plans under the ICICI Blended Scheme, which specialise in arbitrage trades.

This basically means the fund seeks to buy stocks in the cash market and sell the corresponding stock futures to lock-in the price difference between the two, i.e the arbitrage spread. However, this fund will have additional features as in use of options (covered), index arbitrage, pair trading and alpha generation.

This, Mr Shah, feels will mean returns better than a vanilla arbitrage fund. Currently, most arbitrage funds earn annualised returns of around 7.25%, which is nearly the same as that of one-year fixed deposits. Whether a retail investor should opt for such a fund when its returns only match that of a bank deposits is open to debate.

Prior to ’05, Sebi guidelines allowed only 50% investment in derivatives for a mutual fund. In February ’05, JM financial was the first to launch a proper arbitrage fund where the fund was positioned as a 50% in debt and 50% in hedged equity.

Since then quite a few arbitrage funds have mushroomed. Besides, stocks available in F&O counter have increased from 53 stocks in ’05 to 123 stocks now, increasing the opportunities for all funds. Such funds with its investments in cash segments hedged in the derivatives segment basically serve as a variant of a capital protection fund, feel analysts. However, capital protected funds are compulsorily close-ended.  Pru ICICI has now stopped taking subscriptions for its Blended Plans as it feels the opportunities for arbitrage at this stage in derivatives market are limited. Asked whether entry of more MFs in this space will reduce opportunities for arbitrage, Biren Mehta, fund manager of JM’s arbitrage, said this is unlikely.

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