What Are Arbitrage Mutual Funds?

Arbitrage Mutual Funds are hybrid funds that aim to exploit temporary pricing inefficiencies in different market segments. These funds primarily invest in equity and equity-related instruments while simultaneously taking offsetting positions in the futures G derivatives (FGO) market.

➜ How Do They Work?

The fund manager:

• Buys a stock in the cash (spot) market
• Sells the same stock in the futures market simultaneously

When the futures and spot prices converge at the time of expiry, the price difference (the spread) is realized as a profit — regardless of whether the stock price moves up or down in the interim.

˙• How Are Returns Calculated in Arbitrage Funds?

➜ Example Scenario:

• Spot price of Stock A = ₹1,000
• Futures price for the same expiry = ₹1,020
• Spread = ₹20

Assume:

• Investment Amount = ₹1,00,000
• Number of shares = 100 (₹1,00,000 ÷ ₹1,000)

Profit: ₹20 x 100 shares = ₹2,000 

Annualized Return Calculation:

If this arbitrage opportunity lasted for 30 days:

(Profit / Investment Amount) × (365 / Number of days held)

= (₹2,000 / ₹1,00,000) × (365 / 30)

= 0.02 × 12.17 = 24.34% p.a.

Of course, real-world returns are typically more modest, averaging around 5% to 8% per annum (post expenses), depending on market conditions.

Arbitrage Funds vs Other Short-term Investments

Arbitrage Funds Taxation as per the Union Budget 2024-2025

Arbitrage funds are treated just as equity funds for the purpose of arbitrage fund taxation. You make short-term capital gains (STCG) if you stay invested for a time period of less than a year, which are taxable at the rate of 20%.

Your gains will be considered long-term capital gains (LTCG) if you stay invested for more than a year. Such LTCG on arbitrage funds are taxed at 12.5% without any indexation benefits.

Advantages of Arbitrage Funds

• Low-risk, equity taxation benefit
• Attractive alternative to liquid/debt funds for short-term parking
• Ideal during volatile market phases
• Lower tax incidence compared to debt funds and FDs
• Relatively stable returns independent of market direction