Arbitrage Funds

What is an Arbitrage Fund?

Arbitrage funds are hybrid mutual funds that exploit price differences of the same asset across markets. For instance, they may buy a stock in the spot market and sell it in the futures market, aiming for low-risk profits. In practice, arbitrage still carries execution, liquidity, and settlement risks, especially with physical settlement.

These funds can trade in equities, debt, and money market instruments, but generally take offsetting positions (e.g., buy in the cash market and sell in the futures market) to capture pricing gaps. According to SEBI rules, they must invest at least 65% in equities, qualifying for equity taxation. They perform best in volatile markets, where wider price differences create more opportunities for arbitrage gains.

10 Best Arbitrage Funds in India

Here’s a list of some of the leading arbitrage funds in India based on arbitrage fund returns, CRISIL rating, and expense ratios:

Note: Information on arbitrage funds is as of September 11, 2025, and may change with market conditions. Investors should confirm details with official sources before investing.

Key Features of Arbitrage Funds

Key features that make these funds a preferred choice for investors, especially during volatile market conditions, include:

• Equity-Oriented Structure: Must maintain 65%+ allocation in equities and equity-related instruments (hedged), qualifying for equity taxation.

• Hedged Exposure: Positions are primarily offset (cash vs futures), limiting directional market risk.

• Risk Profile: Lower volatility compared to unhedged equities, though returns depend on cash–futures spreads and carry some debt, credit/interest-rate risk.

• Market Suitability: Perform best during volatile phases; spreads narrow in calm markets, reducing returns.

How Does an Arbitrage Mutual Fund Work?

Arbitrage mutual funds generate returns by taking advantage of temporary price differences in different markets for the same security. These differences are usually short-lived, and fund managers use advanced strategies to capture them. Here’s how it works with practical examples:

Scenario 1: Price Difference between Exchanges:

Suppose the stock of ABC Industries trades at ₹2,050 on the National Stock Exchange (NSE) but at ₹2,060 on the Bombay Stock Exchange (BSE). The fund manager buys shares from NSE and simultaneously sells them on BSE. This results in a locked-in profit of ₹10 per share (after costs), without taking any directional market risk.

Scenario 2: Price Difference between Cash and Futures Markets: 

Imagine DEF Ltd. shares are available at ₹750 in the cash market, while the futures contract for the same month is priced at ₹760. The fund manager purchases shares in the cash market and creates a futures contract to sell them at ₹760. On settlement, the shares are delivered against the futures contract, securing a profit of ₹10 per share.

Liquid Funds vs Arbitrage Funds in India

When comparing arbitrage funds and liquid funds, here are the key differences investors should consider before making a choice:

• Different Objectives: Liquid funds are for very short-term investing (up to 90 days). In contrast, arbitrage funds are a suitable option to invest surplus funds for at least three to six months (sometimes up to 12 months), with equity taxation advantage.

• Performance Over Time: As of September 2025, arbitrage funds have delivered ~7–8% returns over one year, compared to ~6–7% for liquid funds. Over longer horizons, the difference remains modest, with arbitrage funds maintaining a slight post-tax edge due to equity taxation. Actual returns vary across market cycles depending on cash–futures spreads and prevailing interest rates.

• Tax Treatment: Arbitrage funds enjoy equity taxation (20% STCG, 12.5% LTCG after ₹1.25 lakh exemption), while liquid funds are taxed as debt funds (slab for ≤3 years; 12.5% LTCG thereafter).

• Risk and Stability: Arbitrage funds carry spread compression and debt credit risk, while liquid funds carry interest-rate/credit risk but no dependence on market volatility.

Why Should You Invest in an Arbitrage Mutual Fund?

Arbitrage mutual funds offer a mix of stability, predictable returns, and tax efficiency, making them a smart addition to a balanced portfolio:

• Lower Risk Profile: Arbitrage funds are designed to minimise exposure to broad market fluctuations by capturing short-term pricing gaps between securities. This makes them less risky than traditional equity funds while offering equity-linked advantages.

• Steady and Predictable Returns: These funds aim to capitalise on small market inefficiencies, offering more stable returns than unhedged equities, though performance can still vary with market conditions.

• Favourable Tax Treatment: Classified as equity funds for taxation, arbitrage funds enjoy favourable treatment. Gains on units held ≤12 months are taxed at 20% (15% before July 23, 2024). Gains on units held >12 months are tax-free up to ₹1.25 lakh per year, with the excess taxed at 12.5% (earlier ₹1 lakh exemption, 10% rate).

Who Should Invest in Arbitrage Funds?

Arbitrage mutual funds suit certain investor needs and can be a smart choice for those seeking stability and tax efficiency. The following types of investors may find them particularly suitable:

• Conservative Investors: Beneficial for individuals seeking low-risk investment avenues that provide the dual advantage of stability and equity-style tax benefits, without heavy exposure to market volatility.

• Short-Term Investors: A suitable option to invest surplus funds for at least three to six months (sometimes up to 12 months), offering better post-tax returns than traditional savings instruments, depending on prevailing interest rates and market spreads.

• Volatility Opportunists: Well-suited for investors who want to make the most of uncertain or choppy markets, as arbitrage strategies thrive when price differences across markets increase.

How to Invest in Arbitrage Funds in India?

Investing in arbitrage mutual funds is simple if you follow a structured approach. Here’s how you can get started step by step:

• Choose the Right Fund: Research arbitrage funds across different asset management companies. Consider the fund’s strategy, manager experience, and historical performance while remembering that past returns don’t guarantee future results.

• Select an Investment Platform: Decide whether to invest directly with the AMC (online or offline), through a registered mutual fund distributor, or via third-party aggregator platforms.

• Complete the Investment Process: Ensure you are KYC-compliant. Submit the required documents, select between a lump-sum or SIP investment, choose your preferred payment method, and initiate the transaction. Investors can also use an arbitrage calculator to estimate potential returns before investing.

Factors to Consider Before Investing in Arbitrage Funds

Before investing in an arbitrage mutual fund, it’s important to understand key factors that can affect returns, risk, and suitability for your portfolio:

• Risk Considerations: Arbitrage funds hedge directional market risk, and counterparty risk is largely mitigated through clearing houses. However, their debt holdings can still carry credit risk, and returns may be lower in falling markets.

• Expected Returns: These funds typically offer moderate, short-to-medium term returns, making them suitable for investors seeking steady income rather than high gains.

• Investment Approach: Arbitrage funds are typically held short-term, so investors often use lump-sum investments; SIPs are less common.

• Scheme Documentation: Reviewing the fund’s offer document is crucial, as it details objectives, strategies, risks, costs, and the asset composition of the fund.

• Asset Allocation: Evaluate how the fund distributes investments between equity and debt, ensuring alignment with your financial goals and risk tolerance.

• Management Fees: Portfolio management charges apply and are deducted from returns; understanding these fees helps gauge net performance and cost-effectiveness.

• Ideal Investment Horizon: Arbitrage funds are best suited for three to six months (up to 12 months). They are not designed for very short-term investing (a few days or weeks), since:

  • Many funds levy an exit load if redeemed within 15–30 days, though some extend this to 60–90 days. Investors should check the scheme document before investing.

  • Spreads may compress in stable markets, limiting short-term returns.

Taxation of Arbitrage Funds in India

For equity-oriented mutual funds (including arbitrage funds), the latest tax rules are:

• Short-Term Capital Gains (STCG): If units are sold within 12 months, gains are taxed at 20% under Section 111A (for sales on or after July 23, 2024). For sales before this date, the rate was 15%.

• Long-Term Capital Gains (LTCG): Units held for more than 12 months enjoy a tax-free exemption of ₹1.25 lakh per financial year. Gains above this limit are taxed 12.5% under Section 112A (effective July 23, 2024). The exemption was ₹1 lakh, and the tax rate was 10%.

• Dividends (IDCW): Dividends are taxed per the investor’s income tax slab. From April 1, 2025, fund houses must deduct 10% TDS on dividends exceeding ₹10,000 per financial year (raised from the earlier threshold of ₹5,000) under Section 194K.

Key Takeaways

Arbitrage funds generate returns by taking advantage of price differences between the cash and derivatives markets. They typically provide lower-risk equity exposure and tax efficiency, making them attractive for certain investors. These funds perform best in volatile markets, while returns may narrow when conditions are stable. Overall, they serve as a lower-volatility option compared to unhedged equities, though outcomes depend on cash–futures spreads.