The rising share of arbitrage funds in futures segment is making it difficult to generate optimum returns, with such funds now accounting for over half of the futures segment open interest (OI).
According to data collated by Capitalmind, arbitrage funds accounted for 51 per cent of single-stock futures OI at the end of June. In June 2020, the total futures contracts for the near-month had an OI of Rs 93,663 crore.
Experts say the recent weakness in returns can be attributed to these funds now being largest players in the single stock futures segment.
“It creates the biggest-player problem. If you are the only elephant in the room, any move you make is noticed by other market participants,” says Deepak Shenoy, founder and chief executive officer of Capitalmind Wealth.
“Other players are aware that the arbitrage funds have to rollover towards end of the month, i.e. buy back the June future and sell the July future. So, a number of July future contracts show a discount and trade lower than June contracts,” he added.
However, fund managers say we need to assess whether this is a temporary issue due to higher market volatility, or a structural problem.
“We must remember that heightened market volatility has also played a part in disrupting future spreads,” said a fund manager.
Source: Capitalmind | Note: Arbitrage funds typically have 65% exposure to stock futures, to offset cash positions
The arbitrage funds as a category saw strong growth in last financial year, as investors sought pockets of safety with credit risks taking a toll on debt schemes.
Since the beginning of last financial year, assets base of arbitrage schemes have risen as much as 71 per cent — from Rs 50,839 crore to peak of over Rs 87,000 crore in February.
Experts say arbitrage funds have also found it difficult to generate returns amid low rates in debt segment.
“Arbitrage funds can make up for lower spreads, through investing some part of scheme assets in shorter-term debt papers. But, the yields in the shorter-end of the curve has been on the lower side,” said Vidya Bala, co-founder of primeinvestor.in
In one-month period, the returns from arbitrage funds are marginally in the negative. The recent weakness in returns has led to concerns among investors.
As a result, the flows in the category have been volatility in last few months. In March, the category saw net outflows of Rs 33,767 crore. In April and May, the category garnered net flows to the tune of Rs 17,393 crore.
Arbitrage funds had also come under pressure earlier in the year, with future prices trading at discount to spot market prices, amid heightened market volatility. Some fund houses had also temporarily suspended fresh flows into their arbitrage schemes.
Advisors say investors can still consider arbitrage schemes, but with a longer time-horizon.
"Investors need to be wary as we have recently seen how sharp volatility in the markets can also impact arbitrage scheme returns. The schemes are suitable for investors looking to park funds for 6-12 months,” said Rushabh Desai, an MF distributor.