[SmartCat]

Originally Posted by anandhsub

I dont think arb funds roll that close to expiry.

They will diversify across expiries. Arbitrage opportunities are dynamic, and fund manager will enter futures contracts with good potential returns, irrespective of time to expiry.

In any case without a settlement price it is not possible for futures to expire. So I believe the last day for futures will be extended in that case. Has happened for a few US interest rate futures.

In case of market shutdowns, the last trading price is taken as the settlement price. However, it is quite possible that exchanges have now implemented Force Majeure clauses, which will result in extension of expiry dates. But even then, there are risks involved. There could be a wide gap between spot and futures prices, immediately on market open after an extended shutdown. That might happen because of difference between liquidity of a stock and its respective futures contract, on the opening day.

The fund's offer document will mention all the market/derivatives related risks that arbitrage funds are subjected to. These risks are extremely low probability risks though - that's why I called it the Black Swan Risk. It's not something to lose sleep over, but it is just something that one should be aware of. Once we are aware of risks, we can take informed decisions on percentage allocation towards arbitrage funds.

[cmody]

Originally Posted by SmartCat

They diversify across expiries. Arbitrage opportunities are dynamic, and fund manager will enter futures contracts with good potential returns, irrespective of time to expiry.



In case of market shutdowns, the last trading price is taken as the settlement price. However, it is quite possible that exchanges have now implemented Force Majeure clauses, which will result in extension of expiry dates.
The fund's offer document will mention all the market/derivatives related risks that arbitrage funds are subjected to. These risks are extremely low probability risks though - that's why I called it the Black Swan Risk. It's not something to lose sleep over, but it is just something that one should be aware of. Once we are aware of risks, we can take informed decisions on percentage allocation towards arbitrage funds.

As stated above in most of the funds it is not necessary that they have sold only the current month futures hence if the fund has even next month futures then the market would need to be shut for more than 1 month for the risk to play out.

Further most funds will roll over the futures contract to the next month from the current month around a week before expiry as the premium becomes very scarce in the last week normally and margins required increase as well.

So any fund will always have a mix of current and later month contracts at any time + liquid instruments. The stock market shut down would need to be more than 10-12 days at a stretch and including a last Thursday of the month to create such a black swan. It's possible but India is one of the largest markets in the world now and seems improbable.

The bigger black swan that can actually occur is if arbitrage funds taxation is changed suddenly to slab rate instead of equity taxation it falls under currently and without any grandfathering etc. and with large redemption the whole spot + futures market goes awry due to liquidity issues as fund magaers will have to square off all positions to meet redemptions. This is more possible in my opinion.

[SmartCat]

Originally Posted by anandhsub

However is there a taxation risk?

Originally Posted by cmody

The bigger black swan that can actually occur is if arbitrage funds taxation is changed suddenly to slab rate instead of equity taxation it falls under currently .

1) I would imagine change in tax treatment will not cause a massive outflow. Because arbitrage funds will not be worse off than other debt funds. So there is no reason for investors to hit the sell button. What is likely to happen is that arbitrage funds segment will start shrinking slowly, because it would struggle to garner AUM.

2) But if less funds are chasing this strategy, returns will get a boost. The premium between spot and futures might widen. So instead of 7% pa, investors might get 8% or 8.5% pa. This will inturn attract more investor money, thereby achieving some sort of equilibrium.

3) Let's assume I'm wrong and there are indeed redemptions. But arbitrage funds can have upto 35% in debt. For eg: the largest arbitrage fund Kotak has 22% in debt. That can be used to take care of trigger-happy redemptions.

4) Arbitrage funds are treated as equity funds, simply because they have 65% plus assets in equities. It is difficult for Govt to specifically exclude arbitrage funds by naming it. What if mutual funds come out with a different name? It is a bit too far fetched to expect Govt to mention a strategy (stock/futures) in their tax laws.

[ZenMaster]

Originally Posted by SmartCat

1)
4) Arbitrage funds are treated as equity funds, simply because they have 65% plus assets in equities. It is difficult for Govt to specifically exclude arbitrage funds by naming it. What if mutual funds come out with a different name? It is a bit too far fetched to expect Govt to mention a strategy (stock/futures) in their tax laws.

Nothing is out of bounds for the govt. and actually its a much higher probability than something like a War.

The govt., and bureaucrats from the MOE had recently publicly mentioned that the govt. Is actively looking to more avenues for taxation and that further increase of Captial Gains Tax is a possibility.

Just looks at the taxation on proceeds from LIC policies which were a favourite of our parents' generation. A lot of them are just finding out now that there are so many tiers of laws that are designed now to make their proceeds Taxable at Slab rate vs how the agents all promised them Tax-free returns. (Sure it was tax free then, until the govt. suddenly decided it won't be anymore)

[whitewing]

Originally Posted by ZenMaster

...
Just looks at the taxation on proceeds from LIC policies which were a favourite of our parents' generation. A lot of them are just finding out now that there are so many tiers of laws that are designed now to make their proceeds Taxable at Slab rate vs how the agents all promised them Tax-free returns. (Sure it was tax free then, until the govt. suddenly decided it won't be anymore)

Has there been a change in the taxation rules?
I thought that the maturity benefits were tax free as long as the annual premium was below 10% of the sum assured.

[DigitalOne]

Originally Posted by whitewing

Has there been a change in the taxation rules?
I thought that the maturity benefits were tax free as long as the annual premium was below 10% of the sum assured.

Not recently. The last tax change for investment products like ULIPs or endowment schemes, sold by Insurance companies was a few years back. As you rightly point out, returns are tax-free if the premium is less than 10%.

This is justified because insurance companies including LIC were selling investment solutions (like MF) and taking advantage of this 'tax-free' loophole.

[ZenMaster]

Originally Posted by whitewing

Has there been a change in the taxation rules?
I thought that the maturity benefits were tax free as long as the annual premium was below 10% of the sum assured.

There is a new Rs. 5 lakh limit for annual premiums.
For policies taken after 1st April 2023, if sum of all your premium exceed Rs.5 lakh oer year, maturity proceeds will be taxable.

[PearlJam]

I was wondering, what is the most "tax-friendly" strategy to park short term funds (say for about 6 months to a year).

FDs, pure debt funds, Savings bank interest (beyond 10k/year) are all taxable at applicable rates.

Even if my general asset allocation strategy is say 60% equity/40% debt, investing in a balanced fund with similar allocations is NOT valid, because the moment I want to liquidate some amount, both the equity/debt parts are touched, which may be undesirable.

PPFs that have crossed 5 years "may" be an option since there is a partial withdrawal option.

Rest of the options seem to have specific lockin periods.

Another option is to invest in extremely low beta stocks.

Thoughts?

[SmartCat]

Originally Posted by PearlJam

I was wondering, what is the most "tax-friendly" strategy to park short term funds (say for about 6 months to a year).

Arbitrage funds. We just discussed this 2 pages back

You get liquid funds like returns (7% pa) with stability, but you pay just 20% STCG tax if units are sold within 12 months and 12.5% LTCG tax if units are sold after 12 months.

[DigitalOne]

Originally Posted by PearlJam

I was wondering, what is the most "tax-friendly" strategy to park short term funds (say for about 6 months to a year).

Arbitrage funds? As I have written in Post#208 above, arbitrage funds will give liquid funds like return but equity fund taxation i.e. 20% STCG. So, if you are in the 30% tax bracket, that's a tax advantage for you.

[xcentrk]

Originally Posted by DigitalOne

Arbitrage funds? As I have written in Post#208 above, arbitrage funds will give liquid funds like return but equity fund taxation i.e. 20% STCG. So, if you are in the 30% tax bracket, that's a tax advantage for you.

So, lets say if I invested 1 Lakh and get 7% return, 7000. In this case, I only have to pay 20% STCG(14k) and don't need to pay income tax on the rest of the fund (1.56L)?

[DigitalOne]

Originally Posted by xcentrk

So, lets say if I invested 1 Lakh and get 7% return, 7000. In this case, I only have to pay 20% STCG(14k) and don't need to pay income tax on the rest of the fund (1.56L)?

Yes. Since your gain is 7000, you pay tax at 20% of 7000 i.e. 1400 and keep the principal of 1,00,000 and rest of the gain of 5,600.

[xcentrk]

Originally Posted by DigitalOne

Yes. Since your gain is 7000, you pay tax at 20% of 7000 i.e. 1400 and keep the principal of 1,00,000 and rest of the gain of 5,600.

Regardless of whether I fall under 30% tax bracket or not?

[clevermax]

Originally Posted by xcentrk

Regardless of whether I fall under 30% tax bracket or not?

Regardless of your income tax bracket, yes your understanding is correct.

[SmartCat]

Originally Posted by xcentrk

Regardless of whether I fall under 30% tax bracket or not?

If you are already getting Rs. 7,000 returns on an investment of Rs. 1 Lakh, that means it is likely you have held the MF close to one year.

Might as well wait to complete one year before selling, so that you can pay just 12.5% tax on gains.