What is an Arbitrage Fund?

Jim B.
Jim B.
Businessman with a briefcase
Businessman with a briefcase

An arbitrage fund is an investment opportunity that accumulates capital for investors through the trading practice known as arbitrage. Most often, arbitrage refers to the practice of traders attempting to benefit from price discrepancies of the same asset on different markets. This could mean that the asset has different prices in different stock exchanges, or it could involve the trading of the asset between the cash and the futures market. Another type of arbitrage fund available focuses on merger arbitrage, which involves taking advantage of the knowledge that a company is about to be bought by another and anticipating a surge in stock price.

Many investors choose to put their money in various funds both for the stability of the returns and the luxury of having their investment controlled by fund managers who have intensive trading knowledge and experience. An arbitrage fund is one such fund available to investors, and it offers the possibility of solid returns because arbitrage actually benefits from market volatility. In addition, risk is relatively low because of the diversification of investments within the fund portfolio.

The skilled arbitragers that work for an arbitrage fund are trained to scour the markets to find the opportunities where quick trades can be made for relatively low-risk profits. This practice is often focused in the past on the price differences that a single asset might have on different stock exchanges. Arbitrage of this sort is currently less prevalent, both because market prices are more closely in conjunction with each other and because there is a significant tax attached to the process of transferring securities across markets.

A typical arbitrage fund gains most of its profits from trading between stocks and their futures. For example, a company might have a lower stock price than the price attached to it on the futures market, so buying the stock and selling the future would be a no-risk profit gained by arbitrage. Even if prices should vary during the time span of the futures contract, simple hedging strategy protects the investment and still can result in a profit. Investors need to be patient for returns, because rolling over such trades often requires a period of several months before they come to full fruition.

Arbitrage funds are often better equipped than the individual investor to take advantage of merger arbitrage, which occurs when stock prices react to the sale of a company. This is because fund managers and the traders in their employ are more likely to have the inside information that these sales are in the offing. If a merger is looming, an arbitrager will buy the stock of the company about to be sold and hope that it rises significantly when the official announcement of the sale is made.

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