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Liquid Funds Vs Arbitrage Funds

There are different mutual funds, and they serve different purposes. Some mutual funds help to achieve long-term goals while other funds cater to our immediate cash requirements.

Liquid funds and arbitrage funds are the two common types of mutual funds that investors invest to park excess funds with relatively lower risk to overcome cash needs.

What are Liquid Funds?

Liquid Fund is a type of debt mutual fund that invest in highly secured debt securities such as treasury bonds, commercial papers. The risk of liquid mutual funds is comparatively lower than other funds. According to the market regulator SEBI, the underlying securities of a liquid fund needs to mature within 91 days.

What are Arbitrage Funds?

Arbitrage Funds are equity funds that aim to take advantage of the price difference between the cash market and the futures market. E.g., you buy a product in one location and sell it in another. Arbitrage funds invest predominantly in arbitrage opportunities that are available in the cash and futuresequities market that makes these funds relatively less risky than other equity funds.

However, which type of fund should you choose to park your money for short-term? Let us take check the differences between liquid funds and arbitrage funds. 

Liquidity:

Liquidity or ease of liquidation of assets is one of the important factors to consider when you are parking money for the short term or for immediate requirements. Liquid funds can be easily redeemed, and the redeemed amount is credited to your bank account. Most of fund houses have introduced instant redemption facility on liquid funds. With the help of this facility, you can instantly redeem up to Rs.50,000 or 90% of your investment value from liquid funds. Fund houses will credit the rest of the amount to your savings account within one or two working days.

As arbitrage funds are equity funds, you will receive the redeemed amount in your bank account in three to five working days.

So, if you are looking for an investment choice that offers instant redemption, you can go for liquid funds.

Tax on Capital Gains:

As liquid funds are debt funds, Long-Term Capital Gains (LTCG) will apply on investments that remained invested over 36 months while Short-Term Capital Gains (STCG) will apply on the units that were redeemed before 36 months. LTCG for liquid funds stands at 20% after considering the indexation benefits. In case of gains from units that stayed invested less than 36 months, gains are added to your income and taxed as per your income tax slab.

As arbitrage funds are equity funds, LTCG is will apply if you remain invested for over 12 months. There are no long-term capital gains if the gains are less than Re.1 lakh. Please note that it includes all equity investments including stocks and other equity mutual funds. For units redeemed before 12 months, 15% tax on capital gains apply.

Arbitrage funds are tax-efficient than liquid funds. You can choose arbitrage fund if you desire tax efficiency.

Risk factor:

The underlying securities of arbitrage funds and liquid funds are different. Arbitrage funds take advantage of the spread between the cash and futures market. So, these funds give high returns when the spread is higher, and the return falls when the spread narrows.

Liquid funds invest in the highest quality debt papers that mature within 91 days. Hence, liquid funds carry less risk than arbitrage funds. You can go for liquid funds if you don’t have technical knowledge of the equity markets.

If you are looking to park funds for short-term needs, liquid funds and arbitrage funds are two popular options. Consider their liquidity factor, tax on capital gains and risk factor before investing in a liquid fund or arbitrage fund.

This blog is purely for educational purpose and not to be treated as a personal advice. Mutual fund investments are subject to market risks, Read all scheme related documents carefully.