The new Closing Auction Session (CAS) reforms, introduced by the Securities and Exchange Board of India (SEBI) in August, is creating some short-term challenges for arbitrage funds, according to Harsh Kumar, Managing Partner and Co-Founder of Zvest Financial Services.
CAS was introduced from Aug. 3 for stocks with derivative contracts. Under the new system, the cash market moves into an auction session from 3:15 pm to 3:35 pm, while equity derivatives continue to trade until 3:40 p.m.
Kumar said the change has created a timing mismatch for arbitrage funds, which buy stocks in the cash market and sell the corresponding futures. Simply put, these funds seek to profit from the price difference between the cash and futures markets.
“Now if you're buying or selling in the cash market, during the auction window, you don't have simultaneous availability of corresponding derivative hedge. And this has added a layer of execution risk in the arbitrage fund,” he explained, while speaking to NDTV Profit, on Aug. 27.
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What Should Investors Do?
To deal with this, Kumar suggested what investors can do to reduce volatility in their portfolio. According to him, it is not recommended to pause investments, but investors may adjust expectations and timing.
For existing investors, he said that there was no reason to panic. Even with the short-term volatility from CAS, arbitrage funds have still delivered meaningful returns expiry-to-expiry over the last month.
“There. I don't see any reason for them to panic because even if we look at expiry in the last month, they have made a meaningful and intended return,” he said.
For new or incremental investors, Kumar advised against putting the entire investment in on a single day.
“Instead of putting the entire sum of money on a single day, I want to suggest that investors spread it... they can take three-four dates in a month and they could ladder their money on those dates to avoid the risk of losing the returns because of a single day market risk,” he added.
He also advised investors to temper their expectations from arbitrage funds. With the introduction of CAS, these funds could see some short-term fluctuations in their NAVs, making returns less predictable than before.
According to him, the impact is smaller on income-plus-arbitrage funds, where 60-65% of the portfolio is typically invested in debt and the rest in arbitrage positions. Still, even after the initial challenges, Kumar believes CAS is positive for the market over the long term.
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