A blog which periodically revisits evergreen investment principles!

Category: Behavioral Finance Page 1 of 2

Identification of funds for a short-term goal

“Arbitrage” is when one simultaneously purchases and sells the same security in different markets to profit from unequal prices. Arbitrage Funds are schemes that invest a minimum of 65% of money in equity stocks and hedge them with corresponding sale of a futures contract, thereby earning a risk-free arbitrage yield when the positions are held till maturity. However, at every given point of time, the spread between the security so purchased and the future contract so sold keeps changing resulting in volatility on returns at that point of time. Yes, the balance of up to 35% can be invested in Debt securities & Money Market Instruments, however the same differs from scheme to scheme.

As against arbitrage, “Liquid” represents being flexible. Liquid Fund schemes primarily invest in money market securities such as treasury bills, commercial papers, certificates of deposits, etc. having a maturity of not more than 91 days.

Post removal of indexation benefit of Debt Mutual Funds, Arbitrage funds have received significant inflows from investors. Gains from Liquid Funds are taxed at Slab rate while Arbitrage Funds qualify for taxation similar to equity-oriented funds (20% short term capital gains tax if redeemed before one year and 12.5% if redeemed after one year)

Source: AMF

Arbitrage returns can be volatile in the short run (less than 3 months):

Arbitrage yields are more volatile because they are dependent on dynamic factors like market liquidity, transaction costs, price corrections, broader economic and regulatory changes, etc. and all of which can fluctuate quickly. Liquid funds, which invest in short-term debt instruments are less volatile.

The 1 month and 3 month rolling return of both the fund in the below chart shows the volatility of arbitrage fund returns which evens out in the medium term

Source: ICRA MFI Explorer (Annualized average Rolling returns of 5 schemes for 3 month and 1 month rolling one month basis) 

The average rolling returns of both arbitrage and liquid Funds over the three-month period are almost similar, making the arbitrage fund more tax efficient over liquid funds. However, one month rolling returns has volatility which investors with short-term goals should be mindful of. 

Exit load: Arbitrage funds have higher exit loads if redeemed quickly and are suitable for investments with a time horizon of more than 3 months. In contrast, liquid funds are designed for safer, short-term parking of funds, with lower exit loads if redeemed within a brief period, usually 7 days. 

Expense Ratio: Arbitrage funds have higher expense ratios due to the complexity of their strategies, their intensive risk management and the infrastructure required to execute trades efficiently. Liquid funds, by contrast, have relatively less operational demand, leading to lower costs.

Arbitrage funds may be more suitable for investors in higher tax brackets with an investment horizon of at least 3 months and who do not mind some volatility in returns.

On the other hand liquid funds are more suitable for investors with shorter investment horizons or those in lower tax brackets due to their lower expenses, stability and liquidity. Ultimately, the choice depends on an investor’s financial goals, risk appetite, and investment horizon. 

Disclaimer: Views are personal  

Statutory Disclaimer:
https://amc.ppfas.com/schemes/riskometer-with-media-disclaimers/ 

What powers the world of Moneylanders?

The Oracle of Omaha once wrote, “It has been far safer to steal large sums with a pen than small sums with a gun” (1988 Chairman’s Letter to Shareholders).

This statement rings loud and clear in an era where entrepreneurs have amassed humongous amounts of illicit wealth by siphoning off shareholders’ money or diverting proceeds from lenders for personal purposes, leaving no distinction between corporate net worth and their own. 

The greed for a lavish life, the desire to meet analysts’ quarterly expectations, to drive up the stock price (they benefit from stock options) makes corporate frauds an endless battle to fight against.

Howard Schilit in his book, ‘Financial Shenanigans’ has very well illuminated the multiple ways by which it is highly possible to dress the financial results and manipulate numbers and stock price.

Do companies get the shareholders they deserve?

Traditional Textbook Economics has the point of view of maximising utility. It means that each individual’s action in the economy is based on the expectation that they will make the maximum possible gain from a transaction. Whereas, behavioural economics has taught us, painfully, that we may not always be doing this well. We may set out with the best intentions of maximum gain but many times our actions fall short of the goal.

It is not the final action, but the motivation underlying the action, that decides what is or is not viewed as cooperative or fair behaviour.
– Games Indians Play by V Raghunathan

Data Habits for the Digital Minimalist

What do we know so far…

  • Every single piece of information is a data point.
  • Very few data points are privileged to become an actionable data point, something that can be used to make a decision.
  • What happens to the remaining data points? They either get accumulated in a large heap of some trend or are ruthlessly forgotten by us for not being relevant.

What is Real?

In the film The Matrix, Morpheus asks Neo after he unplugs Neo from the Matrix,

What is real? How do you define Real?

I think in the age of never ending stimuli that’s perhaps the most relevant question we can ask ourselves. There is an often misrepresented quote –

Ignorance is bliss.

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