What is the reason behind the huge outflows in arbitrage funds?

Arbitrage funds have witnessed significant outflows in the month of June. AMFI data showed that Rs. 1,423 crore were pulled out from arbitrage funds, which is the largest outflow from the category in the current financial year.

The total redemption of arbitrage funds in the current month is around Rs. 5,357 crore. This is more than the redemption in the preceding months. The category has witnessed outflows of Rs. 3,768 crore and Rs. 3,778 crore in the month of May and April, respectively. As compared to this, the category has seen huge redemption, but what can be the possible reasons behind it? Why are investors dumping the funds which are one of the safer investment options?

One primary reason for the outflows is the change in taxation of these funds. In the Union Budget 2018, finance minister introduced 10 per cent tax on both long-term and dividend gains. Previously, these funds are used to have an edge over the debt schemes as they were taxed similar to the equity funds which were tax-free. With the introduction of the tax, investor returns are been hampered by almost 60-70 bps, if we consider the base returns of 6-7 per cent from these funds.

Also, at the same time, with the higher interest rate, the opportunities of the arbitrage minimises. This is another factor which has played a spoilsport for the arbitrage funds. Currently, investors are investing more in liquid funds due to their higher yield to maturity.