Why are arbitrage mutual funds holding debt mutual funds in their portfolios?

Published: October 12, 2022 at 6:00 am

A reader asks, “I noticed that Kotak Arbitrage Fund is holding about 5% of Kotak Liquid Fund. Can you explain why they are doing this?”

Kotak is not alone. Many arbitrage funds buy units of their own debt funds. This is done in a bid to bolster returns. Even a few years back, arbitrage funds could hold about 90% of derivatives and generate returns close to fixed deposits. Arbitrage opportunities have gradually decreased, perhaps due to stabilization of the stock market with increased domestic institutional presence.

After the SEBI categorization rules came into play in mid-2018, Arbitrage funds were reclassified as hybrid funds. They only need to hold 65% of equity and equity-related instruments (derivatives). The rest can be in bonds, cash and related instruments. This allowed mutual funds ample room to buy debt funds units freely (this practice existed even before the rule change).

List of arbitrage mutual funds holding mutual funds units as of Aug 31st 2022

17 out of 26 funds in this category are listed below. The exposure significantly varies from AMC to AMC.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
Scheme Name (names of funds holding more than one fund will be repeated)Company NameHolding(%) Aug 2022
Aditya Birla SL Arbitrage Fund(G)Aditya Birla SL Money Manager Fund(G)-Direct Plan26.6659
Aditya Birla SL Arbitrage Fund(G)Aditya Birla SL Floating Rate Fund(G)-Direct Plan1.1833
Axis Arbitrage Fund-Reg(G)Axis Ultra Short Term Fund(G)-Direct Plan7.8089
Axis Arbitrage Fund-Reg(G)Axis Money Market Fund(G)-Direct Plan7.4410
Axis Arbitrage Fund-Reg(G)Axis Liquid Fund(G)-Direct Plan3.8964
DSP Arbitrage Fund-Reg(G)DSP Savings Fund(G)-Direct Plan0.0957
HDFC Arbitrage-WP(G)HDFC Money Market Fund(G)-Direct Plan8.4323
HDFC Arbitrage-WP(G)HDFC Liquid Fund(G)-Direct Plan7.6369
ICICI Pru Equity-Arbitrage Fund(G)ICICI Pru Savings Fund(G)-Direct Plan6.3655
IDFC Arbitrage Fund-Reg(G)IDFC Cash Fund(G)-Direct Plan6.6381
Invesco India Arbitrage Fund(G)Invesco India Liquid Fund(G)-Direct Plan21.7899
Kotak Equity Arbitrage Fund(G)Kotak Money Market Fund(G)-Direct Plan11.9437
Kotak Equity Arbitrage Fund(G)Kotak Liquid Fund(G)-Direct Plan5.6577
Kotak Equity Arbitrage Fund(G)Kotak Savings Fund(G)-Direct Plan5.6427
L&T Arbitrage Opp Fund-Reg(G)L&T Liquid Fund(G)-Direct Plan0.9729
LIC MF Arbitrage Fund-Reg(G)LIC MF Liquid Fund(G)-Direct Plan25.3797
Mahindra Manulife Arbitrage Yojana-Reg(G)Mahindra Manulife Liquid Fund(G)-Direct Plan22.1402
Nippon India Arbitrage Fund(G)Nippon India Money Market Fund(G)-Direct Plan7.6264
Nippon India Arbitrage Fund(G)Nippon India Liquid Fund(G)-Direct Plan4.8640
Nippon India Arbitrage Fund(G)Nippon India Low Duration Fund(G)-Direct Plan3.9042
PGIM India Arbitrage Fund-Reg(G)PGIM India Liquid Fund(G)-Direct Plan19.2772
SBI Arbitrage Opportunities Fund-Reg(G)SBI Savings Fund(G)-Direct Plan13.8360
Sundaram Arbitrage Fund(G)Sundaram Liquid Fund(G)-Direct Plan11.0610
Tata Arbitrage Fund-Reg(G)Tata Money Market Fund(G)-Direct Plan11.2582
Tata Arbitrage Fund-Reg(G)Tata Liquid Fund(G)-Direct Plan3.7860
Tata Arbitrage Fund-Reg(G)Tata Treasury Advantage Fund(G)-Direct Plan3.1187
Tata Arbitrage Fund-Reg(G)Tata Ultra Short Term Fund(G)-Direct Plan1.0372
Union Arbitrage Fund-Reg(G)Union Liquid Fund(G)-Direct Plan13.8952

List of arbitrage funds not holding mutual fund units as of Aug 31st 2022 (this does not mean they have never held or will never hold such units!)

  1. Bank of India Arbitrage Fund
  2. Baroda BNP Paribas Arbitrage Fund
  3. Edelweiss Arbitrage Fund-Reg(G)
  4. Indiabulls Arbitrage Fund
  5. ITI Arbitrage Fund
  6. JM Arbitrage Fund
  7. Mirae Asset Arbitrage Fund
  8. NJ Arbitrage Fund
  9. UTI Arbitrage Fund

Is this in the best interest of arbitrage fund unitholders? No, it is not. A chunk of their money is used to pay for expenses of the purchased debt fund, lowering returns. More importantly, it increases the risk of holding the arbitrage fund if the debt fund suffers a credit event.

If the AMC is “small” in size, the arbitrage fund could be the biggest holder of the debt fund, increasing the redemption risk of both funds.

AMCs would argue that the underlying holdings would result in better return stability of the arbitrage fund. However, there are ways to achieve this via bonds. It is acceptable for a fund of funds to do this as it is within their mandate to buy other funds. However, an arbitrage fund is not a fund of funds.

It is bad enough that SEBI has rendered this category style impure by making it a hybrid. Allowing arbitrage funds to buy other debt funds only increases the hidden risk. Although it is legal, we hope that SEBI considers imposing a holding limit for mutual fund units in arbitrage fund portfolios.

Investors do not need to fear arbitrage funds or exit them because of this. However,  we recommend existing and potential investors in arbitrage funds investigate the historical portfolio holdings of such funds to appreciate underlying risks.

Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter using the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)