For any investor who wants to optimize their investment strategies, arbitrage mutual funds and portfolio diversification are necessary terms to know.
Basically, an arbitrage fund takes advantage of price differences or inefficiencies in different markets with the objective of earning lower risk but consistent returns. On the other hand, portfolio diversification refers to the act of allocating investments across different asset categories in order to diminish risk while maximizing profits.
In this article, we will look at how these funds operate and what advantages they have for investors’ portfolios in terms of diversification.
What are Arbitrage Mutual Funds?
Arbitrage mutual funds are hybrid mutual funds whose goal is to make a profit from differences in prices in different markets. They purchase and sell, at the same time, different securities, stocks or derivatives within various market segments.
This is a strategy where security is purchased in one market (the spot market) and sold for delivery in another (the futures market) at a higher price.
These types of investments are low risk due to their means of avoiding the volatility of the market, but returns are not known beforehand. They can be held for one to three years as they are taxed, similar to equity funds.
Role of Arbitrage Mutual Funds in Portfolio
Arbitrage mutual funds play a significant role in your portfolio due to their unique characteristics:
1. Diversification
Arbitrage funds are hybrid funds as they invest in both equity and debt. They can help spread risks across different asset classes through this diversification of investments.
By taking advantage of price differences that exist in various markets, they present a one-of-a-kind investment strategy to enhance the overall performance of your portfolio.
This makes them a good option for any investment portfolio and also balances risk with reward.
2. Stability
Arbitrage mutual funds offer portfolio stability. They generate consistent returns like fixed-income investments and are therefore useful during times of economic and financial instability.
In essence, these funds take advantage of price differences across markets regardless of market direction, thereby protecting against market volatility.
This aspect makes them vital to a diversified portfolio, particularly in times of uncertainty.
3. Risk Mitigation
Arbitrage Mutual Funds mitigate risk by seizing on price differences between various markets. They buy and sell securities at the same time, hence reducing exposure to market volatility.
It is not a directional strategy but pricing inefficiencies. As such, they work as insurance against market fluctuations, thereby making them less risky investments.
Nevertheless, the returns are not always assured. Always assess your risk tolerance before you invest.
4. Suitable for Short-Term Goals
Arbitrage Mutual Funds are suitable for short-term investment goals. They take advantage of short-term price movements, making them ideal for parking money for emergency funds or liquidity needs.
An ideal investment horizon can be at least six to 12 months. They could also be suitable for investors with a medium-term horizon of 3 to 5 years.
However, returns are highly dependent on market volatility.
Conclusion
Including arbitrage mutual funds in your investment mix can help spread risk and aim for steady returns. Diversifying across various assets is key to managing market ups and downs.
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