HDFC Arbitrage Fund An Income Generating Equity Investment

[Pages:15]HDFC Arbitrage Fund

(An open ended scheme investing in arbitrage opportunities)

An Income Generating Equity Investment

This product is suitable for investors who are seeking* ? Income over short term. ? Income through arbitrage opportunities between cash and derivative market and arbitrage opportunities within the derivative segment

*Investors should consult their financial advisers if in doubt about whether the product is suitable for them.

October 2019

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Arbitrage ? The Concept

The arbitrage concept works off on mispricing of assets across different markets due to the underlying inefficiencies in market pricing. The illustration alongside gives a general idea of how the arbitrage fund takes advantage of such mis-pricing. All positions are completely hedged and hence the strategy mitigates the risk associated with market volatility.

E.g. Assume stock price of ABC Ltd. is at Rs.190/- in the cash market. This stock is also traded in the derivatives segment, where its future price is Rs.197/- In such a case, one can make a risk-free profit by selling a futures contract of ABC Ltd. at Rs. 197/- and simultaneously buy an equivalent number of shares in the equity market at Rs 190/-. On settlement day, it wouldn't matter which direction the stock price has taken in the interim. Because on the expiry day (settlement date) the price of equity shares and their futures tend to converge. (Also refer illustration on slide 3)

HDFC Mutual Fund/AMC is not guaranteeing returns on investments made in this scheme. The example ignores all transaction related costs.

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Capturing The Difference between Future & Spot

Arbitrage trade is unwound at parity

The above simulation is for illustrative purposes only and should not be construed as a promise on minimum returns and safeguard of capital. The AMC / Mutual Fund is not guaranteeing or promising or forecasting any returns. Particular trade details are for illustrative purposes only and should not be construed as actual trades/positions taken by HDFC MF/AMC.

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Product Rationale & Positioning

Generate income through arbitrage opportunities arising out of pricing mismatch in a security between different markets or as a result of special situations.

Completely hedged positions, neutralizes market risk (volatility) and targets absolute returns irrespective of market conditions.

Enhance portfolio returns using different trading strategies within derivatives segment

Balance of safety, returns and liquidity

Risk

Overnight Funds

Liquid Funds

HDFC Arbitrage Fund

HDFC Ultra Short Term Fund

Short Term Debt Funds

Medium Term Debt Funds

Long Term Debt Funds

Return

In view of the individual circumstances and risk profile, each investor is advised to consult his / her professional advisor before making a decision to invest in the scheme.

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Investment Strategy

Derive returns from the implied cost of carry between the underlying and the derivatives market. This provides an opportunity to provide returns, possibly higher than the short-term interest rate without taking the market risk. Implied cost of carry and mis-pricing across the cash & derivative markets can lead to profitable arbitrage opportunities. The Scheme would carry out strategies, which would be to take offsetting positions on various markets simultaneously. ? No

Naked Positions The overall risk the Scheme would carry would be that of being market neutral i.e. no specific equity risk. When such opportunities are not available, the scheme may invest in debt securities or money market instruments.

In view of the individual circumstances and risk profile, each investor is advised to consult his / her professional advisor before making a decision to invest in the Scheme. For further details on the investment strategy investors should refer to the Scheme Information Document available on website .

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Why Arbitrage funds?

For Individual/HUF

Particulars

Arbitrage Fund Liquid Funds

Investment

`1,00,000 `1,00,000

Dividends in 6 months (-) Dividend Distribution

Tax Net Tax Return

`4,000 `458 ` 3,542

`4,000 `1,119 `2,881

Return (Annualized)

7.08%

5.76%

For Domestic Companies

Particulars

Arbitrage Fund Liquid Funds

Investment

`1,00,000 `1,00,000

Dividends in 6 months (-) Dividend Distribution

Tax Net Tax Return

`4,000 `458 ` 3,542

`4,000 `1,332 `2,668

Return (Annualized)

7.08%

5.34%

A comparison of Liquid funds with Arbitrage funds with dividend option throws up interesting return factors from a taxation perspective.

Particulars

Arbitrage Fund Liquid Funds

Investment

`1,00,000 ` 1,00,000

Return over 6 months

(-) Short Term Capital Gains Tax

Net Tax Return

` 4,000 ` 718 ` 3,282

` 4,000 ` 1,710 ` 2,290

Return (Annualized)

6.56%

4.58%

Particulars

Arbitrage Fund Liquid Funds

Investment

`1,00,000 ` 1,00,000

Return over 6 months

(-) Short Term Capital Gains Tax

Net Tax Return

` 4,000 ` 699 ` 3,301

` 4,000 ` 1,007 ` 2,993

Return (Annualized)

6.60%

5.99%

Same is the case with the growth option

Source: Internal data computation The above simulation is based on highest tax rates applicable to Individual/HUF/Domestic Companies as per Finance Act, 2019 and Finance Act (No. 2) Act, 2019 read with The Taxation Law (Amendment) Ordinance, 2019 (Ordinance 2019) published in the Gazette of India on 20 September, 2019, for illustrative purposes only and should not be construed as a promise on minimum returns and safeguard of capital. It is assumed that the domestic company shall opt for provisions of sec 115BAA. In view of individual nature of the tax consequences, each investor is advised to consult his/her own professional tax advisor. The AMC / Mutual Fund is not guaranteeing or promising or forecasting any returns. These products are not strictly comparable. There is no assurance or guarantee to unit holders as to rate/quantum of dividend distribution nor that the dividends will be paid regularly.

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Equity Taxation ? What works for Arbitrage?

For Resident Individuals/HUF$

Taxes Applicable

Dividend Distribution Tax^ Short Term Capital Gains@ Long Term Capital Gains@@

Arbitrage Funds

11.648% 17.94%/17.16% 11.96%/11.44%#

Liquid Funds/ Debt Funds

29.120%

35.88%/34.32%/39%/42.74%

23.92%/22.88%/26%/28.496%*

^ For the purpose of determining the tax payable, the amount of distributed income be increased to such amount as would, after reduction of tax from such increased amount, be equal to the income distributed by the Mutual Fund. The impact of the same has not been reflected above @ Short Term Capital gains will be considered for equity assets held for a period of up to 12 months and up to 36 months in case of debt assets @@ Assets not falling under short term assets will be treated as long term assets. * After providing Indexation $- Finance (No. 2) Act, 2019 provides for enhanced surcharge at 37%, where income of Individual/HUF exceeds Rs. 5 crores and surcharge at the rate 25%, where income of Individual/HUF exceeds Rs. 2 crores but does not exceed Rs. 5 crores. As per the existing rates, surcharge at 15%, where income of Individual/HUF exceeds Rs. 1 crore but does not exceed Rs. 2 crores and surcharge at 10% to be levied in case of Individual/ HUF where income of such unit holders exceeds Rs 50 lakhs but does not exceed Rs. 1 crore. As per the Taxation Law (Amendment) Ordinance, 2019 the enhanced surcharge inserted vide Finance (No. 2) Act, 2019 has been withdrawn on tax payable by both domestic and foreign investors at special rate on income in the nature of long-term and short-term capital gains arising from the transfer of equity share/unit referred to in section 111A and section 112A of the Act #Exemption granted w.r.t. equity oriented fund u/s 10(38) of the Income-tax Act, 1961 has been withdrawn and tax at 10% (without indexation) will be charged on long-term capital gain exceeding Rs. 1 lakh provided that transfer of such units is subject to STT.

The information set out is neither a complete disclosure of every material fact of Income-tax Act 1961 nor does it constitute tax or legal advice. In view of the individual nature of the tax consequences, each investor is advised to consult his/her own professional tax advisor.

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Equity Taxation ? What works for Arbitrage?

For Domestic Companies$

Taxes Applicable

Dividend Distribution Tax&

Arbitrage Funds

11.648%

Liquid Funds/ Debt Funds

34.944%

Short Term Capital Gains@ Long Term Capital Gains@@

17.472%/16.692% 11.648%/11.128%#

25.17^ 23.296%/22.256%*

& For the purpose of determining the tax payable, the amount of distributed income be increased to such amount as would, after reduction of tax from such increased amount, be equal to the income distributed by the Mutual Fund. The impact of the same has not been reflected above @ Short Term Capital gains will be considered for equity assets held for a period of up to 12 months and up to 36 months in case of debt assets @@ Assets not falling under short term assets will be treated as long term assets. * After providing Indexation $- Surcharge at the rate of 7% is levied for domestic corporate unit holders where the income exceeds Rs 1 crore but is less than Rs 10 crores and at the rate of 12%, where income exceeds Rs 10 crores. ^ - It is assumed that the domestic company shall opt for provisions of sec 115BAA . Accordingly, surcharge rate of 10% shall be applicable #Exemption granted w.r.t. equity oriented fund u/s 10(38) of the Income-tax Act, 1961 has been withdrawn and tax at 10% (without indexation) will be charged on long-term capital gain exceeding Rs. 1 lakh provided that transfer of such units is subject to STT.

- Domestic companies may subject to minimum alternate tax which is not specified in above tax rates. Not applicable in case domestic company has opted for sec 115BAA The information set out is neither a complete disclosure of every material fact of Income-tax Act 1961 nor does it constitute tax or legal advice. In view of the individual nature of the tax consequences, each investor is advised to consult his/her own professional tax advisor.

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