Mutual Fund Industry Proposes Cash-Linked Futures Price To Curb NAV Volatility

Mutual fund houses have flagged a problem with how equity futures get priced at the end of the trading day, and they've now put forward a fix. The concern, centres on arbitrage funds, a category of mutual fund schemes that have seen their NAVs swing unpredictably because of a quirk in how closing prices are calculated across two connected markets.

Arbitrage funds run a fairly simple strategy; buy a stock in the cash segment, sell the equivalent futures contract at the same time, and pocket the difference between the two. Since both legs are supposed to cancel each other out, the strategy is considered low-risk, which is exactly why the category has attracted close to ₹3.5 lakh crore in investor money.

The strategy only works cleanly, though, if both legs close at prices that reflect the same moment in time. That stopped being the case once exchanges introduced the Closing Auction Session (CAS) for cash-market stocks. The auction now decides where a stock's cash price lands at close. Futures contracts, meanwhile, keep trading for a while longer and settle using an entirely different formula.

The result is a timing gap between the two legs of what should be a hedged trade. On some days, that gap is small. On others, it is wide enough to swing an arbitrage fund's NAV in ways that have nothing to do with actual market risk, purely because one leg closed earlier than the other. Fund managers reportedly say this has made entry and exit prices unreliable for investors moving in or out of these schemes on volatile days.

What The Industry Wants Instead

Rather than let futures find their own closing price independently, the mutual fund industry wants that price to be calculated off the cash market's final auction number, according to a report by Moneycontrol. The proposed method would take the CAS closing price and add a spread, essentially the usual gap between cash and futures prices, measured over a short window right before the market shuts.

That spread itself would come from comparing the volume-weighted average price (VWAP) of the cash market against the average futures price during this pre-close window. Exchanges and the regulator would still need to settle on the exact duration of that window and the finer points of the formula.

The underlying logic is straightforward. Once the cash price is locked in, the futures price should follow from it in a predictable, calculable way, rather than being left to trade independently and drift apart.

There's a secondary effect the industry hasn't missed. If futures prices are tied directly to the cash auction outcome, exchanges may no longer need to keep derivatives trading open after the cash market shuts, purely to generate an independent close. That opens the door, at least in theory, to both markets closing at the same time. This would need much bigger changes to market infrastructure before it could happen, the report added.

Any fix here also can't stay limited to arbitrage funds alone. The futures closing price feeds into settlement, margining and mark-to-market calculations across the entire derivatives market, so regulators would likely have to apply any new formula uniformly rather than carve out a special rule for one category of mutual funds. That means exchanges and clearing corporations would also need to adjust their own systems.

For now, fund managers are treating this as urgent. Arbitrage schemes are meant to be a steady, low-drama option for parking money, and unpredictable NAV swings work against that pitch. There are also concerns, industry participants say, that the current system leaves entry and exit prices open to question.