In a climate marked by economic uncertainty and market fluctuations, arbitrage funds have recently seen a surge in interest. These funds, designed to capitalize on pricing mismatches between equity spot and futures markets, have gained traction for their relative stability, especially during periods of elevated volatility. Their structure allows them to operate without taking directional equity exposure, and recent tax updates have brought further attention to this category.
Arbitrage funds function by locking in price differences between the cash and futures markets. For instance, when a stock is available at Rs 100 in the cash market and Rs 101.50 in the futures market, the fund can buy the stock in the cash segment and sell in the futures, thus securing a profit margin. This strategy tends to become more active and relevant when market volatility is high, such as during earnings announcements or global geopolitical developments.
Over the past year, arbitrage funds have witnessed fluctuating yet significant inflows. In April 2025 alone, these funds recorded net inflows of Rs 13,901 crore, with further increases seen in subsequent months. This behaviour suggests that many investors are currently allocating funds to this category, possibly as a measure against broader market unpredictability. It’s also notable that arbitrage funds, by their design, are generally considered low-risk instruments because they are not exposed to market direction.
Taxation Changes: What You Need To Know
Taxation norms for arbitrage funds were revised in mid-2024. As per the current regime, short-term capital gains on such funds (for units held up to 12 months) are taxed at 20 per cent, while long-term capital gains (for holdings beyond 12 months) are taxed at 12.5 per cent on gains exceeding Rs 1.25 lakh in a financial year. The initial Rs 1.25 lakh remains exempt. This tax structure, while different from the earlier one, still remains distinct compared to traditional debt fund taxation, where gains are taxed as per the investor’s income slab.
Even after the increase in short-term capital gains tax, arbitrage funds may continue to offer competitive post-tax outcomes, especially when compared to traditional fixed-income products taxed at higher rates for investors in upper tax brackets. For instance, assuming a 6 per cent annual return, a debt fund might yield approximately 4.2 per cent post-tax for someone in the 30 per cent slab, while an arbitrage fund may still deliver a higher post-tax return due to its different tax treatment.
Arbitrage funds are often discussed alongside other short-term parking options such as liquid funds, fixed deposits, or savings accounts. While each of these instruments has its own features and risks, arbitrage funds derive their returns from market inefficiencies rather than interest rates. This makes them less sensitive to rate changes and offers an alternate route for those seeking short-duration investments.
Recent data suggests a wide spectrum of users, including individuals with short-term surplus capital, corporate treasuries, and institutional players, are allocating money to arbitrage funds. The horizon for such investments typically ranges from a few weeks to a few months. These funds may also appeal to those awaiting better opportunities in equities or those rebalancing their portfolios in light of tax reforms and liquidity needs.
Risks And Limitations
While the risk profile of arbitrage funds is generally low, it’s important to note that these schemes are not entirely risk-free. If market volatility is subdued, arbitrage opportunities may diminish, impacting potential returns. Regulatory changes or reduced derivatives turnover can also affect fund performance. Sudden market shocks can cause short-term mark-to-market fluctuations, though these are usually limited compared to equity funds.
Data from the June quarter of FY 2025–26 indicates inflows of over Rs 43,000 crore into arbitrage schemes. This increase appears to be aligned with rising market uncertainty and an increase in derivative activity. Some investors who had earlier exited debt schemes after changes in their tax treatment seem to be reallocating to arbitrage funds as an alternative.
Most arbitrage funds offer T+1 or T+2 settlement cycles, ensuring relatively fast access to invested capital. However, an exit load of around 0.25 percent may apply for redemptions made within 30 days. This is an important point for those considering arbitrage funds for ultra-short-term needs, as early exits may slightly reduce net gains.
The recent increase in arbitrage fund flows appears to reflect a broader market sentiment where safety, liquidity, and tax efficiency are being prioritised. These funds, without promising equity-like upside, are being considered by a segment of investors for their predictable returns and low sensitivity to market shocks. Their utility lies in capital preservation and tactical deployment during market transitions.
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