Income-Plus Arbitrage Fund of Fund: Maximize your returns: Understanding income-plus-arbitrage fund of funds for tax efficiency

Income-plus-arbitrage fund of fund (FoF) schemes are increasingly attracting interest from fixed-income investors due to their tax efficiency. These funds invest less than 65% in fixed income and the balance in arbitrage strategies. This structure allows gains from the investments to be treated as long-term capital gains (LTCG) if held for more than 24 months and taxed at 12.5%, attracting rich investors and family offices.

WHAT IS AN INCOME PLUS ARBITRAGE FUND OF FUND (FOF) ?
This is an open-ended mutual fund scheme that primarily invests in the units of two distinct categories of underlying mutual fund schemes: debt-oriented schemes and arbitrage schemes. The objective of this FoF is to provide a combination of stability and income from the debt portion, along with tax efficiency and lowrisk returns from the arbitrage portion.

HOW MANY SCHEMES ARE THERE IN THIS CATEGORY?
As per data from Value Research, there are 18 schemes, which manage Rs 21,000 crore as of September 30.

HOW DO THESE SCHEMES WORK?
These funds are typically structured to dynamically allocate assets to achieve their twin goals of income and tax efficiency. They generally maintain an allocation where investments in debt mutual fund schemes are kept under 65% (50-65%) and the balance is invested in equity arbitrage schemes (35-50%). The debt portion aims to generate stable returns and income by investing in various fixed-income instruments like corporate bonds, government securities, or money market instruments through the underlying debt schemes. The fund manager actively manages the duration and credit risk of this portion. The arbitrage portion is invested in a scheme that capitalises on the price differences of the same security between cash and futures market by simultaneous buying and selling. This strategy is considered lowrisk as the fund manager does not take a directional call on the market. The fund can invest in the debt and arbitrage schemes of its own fund house or can also use schemes from other fund houses.

WHY IS THE INCOMEPLUS-ARBITRAGE FOF TAX EFFICIENT?
By maintaining a minimum exposure to equity-related instruments using arbitrage funds, the FoF qualifies for long-term capital gains if held for more than 24 months. Gains are taxed at 12.5%, compared to debt funds and fixed deposits where gains are taxed at the investor’s personal income tax slab rate.