MF QueryBoard

MF QueryBoard

Readers are requested to send only one query at a time so that more readers get a chance. Have questions relating to any aspect of personal finance. Ask DSIJ at editorial@DSIJ.in and get your queries resolved.

I have invested in a small-cap fund. Should I move out of it now and re-enter once the market stabilises?
 - Anmol Raheja

It takes a long time for small-caps to do well and those who bear the pain get rewarded. These funds tend to fall freely in any kind of market correction. This can be seen from the performance of the small-caps. If we look at the performance of Nifty 250 Small-Cap TRI, in the global financial crises of 2008 it corrected close to 76 per cent and then took almost one year and four months to reach to its previous high made in the year 2008. Further, even to generate 10 per cent returns on an absolute basis it took close to two years and five months. Therefore, we can say that indeed it is a game of patience.

Hence, investing in this fund requires psychological strength to stomach the stressful periods and display patience to reap a rich harvest. Even before the pandemic struck, we did see a bloodbath in the small-cap space. In 2018, small-cap funds on an average were staring at negative 18.62 per cent returns. Hence, if it forms a small part of your overall investment portfolio, it would be worthwhile to continue with your SIP. However, if your investment horizon is not more than 7-10 years, reconsider investing in small-cap funds.

The reality check here is that it is really difficult to time investments in small-cap funds and earn the desired returns. This is because most of the big moves happen when you least imagine them to do so. For example, if in a single day the small-cap indices rally by 7-8 per cent, you might consider yourself a loser. Hence, in the small-cap space, gains come in a short span of time and this makes it difficult for investors to time them. As such, it makes sense to first look at your purpose and horizon of investment and then consider exiting and entering into small-cap funds. Also, stick to your financial plan and make investment decisions based on that. Abruptly entering and exiting your investment would not benefit you in the long term.

As arbitrage funds have tax treatment similar to equity funds, is it wise to invest in arbitrage funds for short-term over debt funds?
- Amit Pandey

Arbitrage funds are those that derive returns from the arbitrage between the future and the cash market. They can prove to be reasonably safe as these funds mainly invest in arbitrage opportunities and don’t take any credit bets. In the case of arbitrage funds, greater the volatility, more the opportunities. However, if the volatility slides, these funds can fail miserably. That said, there is a regulatory mechanism in place which makes these funds reasonably safe.

As arbitrage funds are low-risk investment products, the risk-returns payoff is similar to that of liquid funds. If we compare the returns with that of liquid funds, then on a trailing basis, apart from year-till-date (YTD) returns, in all other periods liquid funds have successfully outperformed arbitrage funds. Even most of the other short-term debt funds such as money market funds, short duration funds and ultra-short duration funds performed better than arbitrage funds. You have rightly pointed out that the tax treatment of arbitrage funds is similar to that of equity funds. However, at times there are not enough arbitrage opportunities available due to which they have to invest in fixed income securities. So, if in case they invest beyond 35 per cent in debt or debtoriented securities, they may not be able to qualify for advantageous taxation like equity funds. Such a situation creates a problem. Therefore, one should be very careful while investing in arbitrage funds.

Further, if you don’t fall in the highest tax bracket, you can certainly avoid investing in arbitrage funds. Those who wish to invest in them should not park the whole sum in arbitrage funds. Rather, divide it equally among arbitrage and debt funds. Even those who are retired and need to park lump sum amounts for systematic withdrawal can consider part investment in arbitrage funds and part in debt funds. This would help in getting tax-efficient returns. Readers are requested to send only one query at a time so that more readers get a chance. Have questions relating to any aspect of personal finance. Ask DSIJ at editorial@DSIJ.in and get your queries resolved.

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