In the one-year period ending September 23, 2008, youshould credit yourself as a good fund manager if you have not lost any money,let alone got some returns. Which coveted also managed toperform the same feat? Among the mutual fund investment arena in India, debtfunds for sure.

Equity mutual funds as an investment? None of you wouldeven hazard a guess. This is understandable considering that during thisperiod, the benchmark index Sensex lost about 20 per cent of its value. But acategory of equity funds braved this storm: arbitrage funds.Only 10 equity funds managed to stay afloat in theone-year period ending 23, September 2008. And within this pack, the firstseven positions in the list were taken by arbitrage funds. The rest went topharma funds. Topping this list is UTI Spread Fund (Growth) with gave a returnclose to 9 per cent. It was followed by JM Arbitrage Advantage Fund (Growth),which also rose more than 8 per cent. 

The other arbitrage funds in the list are ICICIPrudential Blended Plan - Option A (Growth); Kotak Equity Arbitrage Fund ?Growth; SBI Arbitrage Opportunities Fund ? Growth; HDFC Arbitrage Fund - Plan B(Institutional) ? Growth; and HDFC Arbitrage Fund - Plan A (Regular) ? Growth.This category of try to provide capitalappreciation through arbitrage opportunities between the cash and derivativemarket. Arbitrage funds primarily invest in equity and equity-relatedsecurities, and derivatives. The rest is parked in debt securities.

How did these funds manage to sail smoothly in the roughweather? Well, the modus operandi of these funds provided a safety net.Arbitrage funds prey on pricing gap between the cash and future market. Forexample, a stock X is trading at Rs 100 in the cash segment and Rs 102 in thefutures market.

The fund manager enters into a futures contract to sellthe stock at Rs 102 and buys at Rs 100 in the cash segment. Meanwhile,irrespective of the market movement till the futures settlement day or until hesquares off the position, the fund manger makes a profit of Rs 2 on a stock.Similarly, the fund manager can also make profit even if the futures aretrading at a discount to the spot prices. These funds offer a low-risk wayof benefiting from the equity markets. As the risk profile is relatively low,the returns are moderate.

On top of that, arbitrage funds offer the tax advantageas that of equity funds. As arbitrage funds invest mostly in equity orequity-related instruments, they are treated as equity funds. So they attractlower short-term capital gain tax of 10 per cent and are completely tax-freeafter one year. Though the top-performing debt funds during this period offeredhigher returns than arbitrage funds, the debt funds don't offer that taxadvantage. For long-term capital gains, debt funds are taxed at 10 per centwithout indexetion or 20 per cent with indexation, whichever is lower, plus 10per cent and 3 per cent cess. This translates to 11.33 per cent withoutindexation, or 22.66 per cent with indexation. And for short term capitalgains, debt funds are taxed at 33.39 per cent vs 10 per cent for equityfunds.