In the world of investing, there are times when individuals or institutions have surplus funds that are not immediately needed but shouldn’t remain idle. During such periods, parking this money in short-term, low-risk investment options can help generate returns while maintaining liquidity. When looking to park idle funds for a short period while earning returns, mutual funds offer attractive options like Liquid Funds and Arbitrage Funds.
While both are low-risk and provide similar returns, they differ in structure and cater to different investor needs. Liquid Funds focus on short-term debt instruments for quick liquidity, whereas Arbitrage Funds use market price differences to generate returns with equity-like taxation benefits. Understanding these differences helps investors choose the right option based on their goals and risk appetite.
– What are Liquid Funds?
Liquid funds are short-duration debt mutual funds that invest in money market instruments like treasury bills, commercial papers, and certificates of deposit with maturities of up to 91 days. They offer high liquidity, no lock-in period, and can be redeemed within one business day, making them ideal for short-term investments.
– What are Arbitrage funds?
Arbitrage funds are hybrid mutual funds that invest mostly in equities (65% or more) and the rest in debt instruments. They use price differences between cash and futures markets to earn low-risk profits by buying low and selling high. For example, if a stock is priced at ₹100 in one market and ₹110 in another, the fund buys in the lower-priced market and sells in the higher-priced one, profiting from the difference. This strategy ensures 100% hedging. Though equity-based, their fully hedged strategy makes them relatively safe. Arbitrage funds typically offer moderate returns and are taxed at 12.5% (LTCG) if held for over a year. Redemption from these funds usually takes 2-3 business days.
– Pros of Liquid Mutual Funds vs Arbitrage Mutual Funds
Particulars | Pros of Liquid Mutual Funds | Pros of Arbitrage Liquid Funds |
Risk Level | Very low risk – invests in high-quality, short-term debt instruments with maturities up to 91 days. | Low risk due to fully hedged equity positions (buying in cash market, selling in futures market). |
Tax Efficiency | Added to income and taxed at applicable slab rate | Treated as equity for taxation—LTCG taxed at 12.5% if held for more than 1 year, better than slab-based taxation. |
Returns | Generally better than savings account returns, while maintaining capital safety. | Potential for moderate returns, often higher than savings or liquid funds, especially in volatile markets. |
Liquidity | Highly liquid – redemption usually processed within T+1 day; some AMCs offer instant redemption options. | Fairly liquid—redemption processed in 2–3 business days. |
– Cons of Liquid Mutual Funds vs Arbitrage Mutual Funds
Particulars | Cons of Liquid Mutual Funds | Cons of Arbitrage Liquid Funds |
Risk Level | Minimal interest rate and credit risk still exists, especially if instruments are not AAA-rated. | Returns depend on the availability of arbitrage opportunities, which can be limited in calm or less volatile markets. |
Tax Efficiency | Gains are taxed as per individual’s income tax slab, making it less tax-efficient for high-income investors. | Short-term gains (<1 year) taxed at 20%, which can reduce returns if held briefly. |
Returns | Returns are lower than other mutual fund categories like arbitrage or short-term debt funds. | Returns are not guaranteed and may be lower in stable markets with fewer arbitrage gaps. |
Liquidity | Some funds may impose an exit load if redeemed within 7 days (though rare and minimal). | Less liquid compared to liquid funds which offer T+1 or instant redemption. |
– Conclusion:
Both Arbitrage Funds and Liquid Funds offer investors relatively low-risk avenues for stable returns, each catering to different financial needs and investment horizons. Arbitrage funds, with their hedged equity strategy, are well-suited for those seeking moderate returns over a short- to medium-term period, along with favourable tax treatment. On the other hand, Liquid Funds provide a safe and highly liquid parking option for surplus cash, making them ideal for short-term goals and emergency funds. By understanding the structure, benefits, and risks of each, investors can effectively incorporate these instruments into a diversified portfolio aligned with their financial objectives.
To understand more on the topic as well as to start investments please feel free to contact us:
Phone: +91-9324609115
E-mail: team@richvikwealth.in