What is an Arbitrage Fund?
An arbitrage mutual fund simultaneously buys shares in the cash (spot) market and sells them in the futures market at a higher price, locking in a risk-free profit. The fund captures the difference (called "basis") between the spot price and the futures price. Since both legs of the trade are placed simultaneously, there is virtually no market risk — the profit is locked in from the moment of trade.
Example: If Reliance shares trade at ₹2,800 in the spot market and the one-month futures contract trades at ₹2,830, an arbitrage fund buys at ₹2,800 and sells futures at ₹2,830, locking in ₹30 per share profit (~1.07% for the month) regardless of where the stock moves.
How Arbitrage Funds Are Taxed
This is the key advantage. SEBI mandates that arbitrage funds maintain at least 65% equity exposure (achieved through the hedged equity positions). Because of this, arbitrage funds are classified as equity funds for taxation:
- Held less than 1 year: STCG at 20%
- Held 1 year or more: LTCG at 12.5% (with ₹1.25L annual exemption)
- Dividend option: 10% DDT
Compare this to a liquid fund or short-duration debt fund, where returns are taxed at your income slab rate (up to 30%). For someone in the 30% slab, an arbitrage fund generating 6.5% returns is equivalent to a debt fund generating ~8.5% returns pre-tax. This makes a huge difference for high-income earners.
Returns: What to Expect
Arbitrage fund returns are closely tied to the spread between cash and futures prices, which in turn correlates with overall market sentiment and short-term interest rates:
- In volatile, bullish markets: arbitrage spread widens, returns improve (6.5–7.5% annualised)
- In flat, low-volatility markets: spread compresses, returns fall (5–6% annualised)
- Long-term average: roughly 50–100 basis points above overnight/liquid fund returns
Risk Profile
Arbitrage funds have very low market risk because every position is hedged. However:
- Execution risk: In fast markets, the cash and futures leg may not execute at expected prices simultaneously
- Futures rollover risk: Futures expire monthly. Rolling positions to the next month sometimes results in unfavorable pricing
- Lower yield in range-bound markets: If fewer arbitrage opportunities exist, the fund may hold more of its cash in overnight instruments earning lower returns
Overall, arbitrage funds have never delivered negative annual returns in India — they are among the most stable mutual fund categories.
Ideal Use Cases — 3 to 12 Months
Arbitrage funds are best suited for money you need in 3–12 months where tax efficiency matters:
- Emergency fund top-up (better post-tax than FD for high-income earners)
- Parking bonus/salary surplus for 6–12 months before deployment into equity
- Short-term goal saving (vacation, gadget, down payment top-up)
- Not ideal for less than 3 months: exit load (usually 0.25% for 30-day exit) and STCG at 20% can make it worse than a liquid fund
Popular Arbitrage Funds in India
- Nippon India Arbitrage Fund — one of the largest AUM, consistent returns
- ICICI Prudential Equity-Arbitrage Fund — well-managed with strong track record
- Kotak Equity Arbitrage Fund — high AUM, liquid
- SBI Arbitrage Opportunities Fund — good for those preferring PSU AMC
Most arbitrage funds have a 30-day exit load of 0.25% and then become free to exit. Look for funds with AUM above ₹5,000 crore for liquidity comfort.