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Income + Arbitrage FoFs gain ground in choppy market
Income plus arbitrage fund of funds (FoF)-a category that allocates just under 65% to fixed income with the balance to equity arbitrage strategies-has seen its assets grow by 75% to nearly ‘23,500 in February from June last year, according to data from Value Research. With equity’s prospects turning hazier in the wake of the West Asia conflict, investment advisors expect the product to become more popular among investors.
“Investors are hesitant to allocate more to equity as the impact is unknown given the geopolitical tensions around the globe,” says S Shankar, certified financial planner, Credo Capital. “They are allocating new money to safe and tax-efficient strategies like the income plus arbitrage fund of funds.”
The category came into prominence in February last year after mutual funds repackaged some of their existing debt schemes as fund of funds (FoFs) – a product that invests in a collection of other funds- to take advantage of the tax benefits for this category announced in the 2025 budget. What were originally debt schemes were refurbished as fixed income plus arbitrage that reduced the tax outgo for investors.
Gains from Income plus arbitrage fund of funds are taxed at 12.5% if held for more than 24 months. In comparison, capital gains from plain vanilla debt schemes are taxed as per the tax slabs. Most fund houses run portfolios under this category with a yield to maturity (YTM) of around 6.9-7.1%.
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After accounting for expenses, these schemes could fetch returns of 6.5 – 6.75% .
“We have maintained duration around 2.5 years as a strategy to generate capital gains when yields come down as well as earn high accruals,” says Shantanu Godambe, fund manager, DSP Mutual Fund. Some fund managers follow a core-and-satellite strategy, keeping a large portion of the portfolio in fixed income while using a smaller allocation for trading opportunities in bonds. “The core fixed income portfolio is positioned in line with the medium term view on bond yields, while some allocation could be based on the tactical view on the bond market,” says Dhawal Dalal, president & CIO-fixed income, Edelweiss Asset Management.
