When it comes to investing in mutual funds, most people think of equity or debt funds. But there is a lesser-known option that offers a unique combination of low risk and reasonable returns – arbitrage funds. If you are curious to know what arbitrage funds are, how they work, what their benefits are and how to choose the best funds using tools like arbitrage calculators, you are in the right place.
This guide will explain everything you need to know about arbitrage funds in simple terms – from their basic meaning to a list of top-performing funds and how to calculate returns effectively.
What is an arbitrage fund?
An arbitrage fund is a type of hybrid mutual fund that leverages the price difference of the same asset in different markets to generate returns. It essentially makes profits through arbitrage opportunities – buying at a lower price in one market and selling at a higher price in another.
In the context of Indian markets, arbitrage usually involves buying stocks in the cash (spot) market and simultaneously selling them in the futures (derivatives) market, where prices are higher. The difference between the two prices (called the arbitrage spread) is the fund’s return.
This investment strategy is considered low-risk as both transactions happen simultaneously, reducing the risk of market volatility.
Arbitrage Fund Meaning – Explained Simply
To put it simply, arbitrage means taking advantage of price differences. Let’s say a stock is available for ₹100 in the cash market but ₹102 in the futures market. An arbitrage fund will buy the stock in the cash market and sell it in the futures market. When both transactions settle, the fund earns ₹2 per share, minus costs.
So, “arbitrage fund meaning” is:
A mutual fund that tries to generate profits by exploiting short-term price differences in stock markets using a low-risk trading strategy.
These funds are categorized under hybrid funds because they typically invest in both equity and debt instruments. The equity part is used for arbitrage, while the debt portion ensures liquidity and stability.
How do arbitrage funds work?
Arbitrage funds operate by exploiting temporary inefficiencies in the stock market. Here’s a step-by-step breakdown:
- Find the difference in price: The fund manager looks for stocks trading at different prices in the cash and futures markets.
- Simultaneous Buy & Sell: The fund buys the stock in the cash market and sells it in the futures market, locking in the price difference.
- Hold Till Expiry: On the expiry date of the futures contract (typically the last Thursday of the month), both positions are squared off.
- Profit Booking :The fund earns the price difference (spread), which becomes the return for investors.
- Debt Allocation: A part of the fund is also parked in short-term debt instruments or fixed-income securities to provide steady returns and manage liquidity.
Key Features:
- Low Risk: Profits are locked in at the time of trade, minimizing market risk.
- Short-Term Focus: Most trades span days or weeks, capitalizing on fleeting opportunities.
- Equity Taxation: In India, these funds are taxed like equity funds if held over 12 months (10% tax on gains over ₹1 lakh).
Who Should Invest in Arbitrage Funds?
Arbitrage funds are ideal for:
- Low-risk investors who are looking for better returns than traditional savings instruments.
- Short to medium-term investors who want to park the funds for 3-12 months.
- People in higher tax brackets, as arbitrage funds enjoy equity-like tax treatment (discussed below).
- People who want to diversify their investment portfolio.
Benefits of Arbitrage Funds
- Lower Volatility: Returns rely on arbitrage spreads, not market swings.
- Tax Efficiency: Better post-tax returns compared to debt funds for short-term holdings.
- Liquidity: Most arbitrage funds allow redemptions within 1–3 days.
- Ideal for Uncertain Markets: Perform well during sideways or volatile markets.
Risks and Limitations of Arbitrage Funds
No investment is completely risk-free. Arbitrage funds have some limitations as well:
- Returns are not guaranteed – profits depend on market inefficiencies, which may not always be present.
- Lower returns in stable markets – When the market is stable or calm, arbitrage opportunities are reduced.
- Short-term gains are taxable – if held for less than a year, these are subject to short-term capital gains tax.
Best Arbitrage Funds in 2024
Here is a list of some of the best arbitrage funds based on consistent performance, asset size, and risk profile.
| Fund Name | 1-Year Return* | AUM (₹ Cr) | Expense Ratio | Risk Level |
|---|---|---|---|---|
| Nippon India Arbitrage Fund | 6.5% | 13,000+ | 0.35% | Low |
| Kotak Equity Arbitrage Fund | 6.7% | 28,000+ | 0.37% | Low |
| ICICI Prudential Equity Arbitrage Fund | 6.6% | 20,000+ | 0.38% | Low |
| Axis Arbitrage Fund | 6.4% | 4,000+ | 0.40% | Low |
| Edelweiss Arbitrage Fund | 6.5% | 2,500+ | 0.36% | Low |
*Returns are approximate and as of Q1 2025. Returns may vary based on market conditions.
Selection Tips:
- Compare expense ratios (aim for <0.5%).
- Check historical consistency, not just peak returns.
- Opt for funds with large AUM for better liquidity.
How to Use an Arbitrage Calculator
An arbitrage calculator helps estimate potential returns. Here’s how to use one:
Steps:
- Enter Investment Amount: E.g., ₹1 lakh.
- Select Duration: 1 month to 3 years.
- Input Expected Return: Based on fund history (e.g., 7% annually).
Formula:Maturity Amount=P×(1+rn)n×tMaturity Amount=P×(1+nr)n×t
Where:
- PP = Principal
- rr = Annual return (decimal)
- nn = Compounding frequency
- tt = Time in years
Example:
Investing ₹1 lakh for 1 year at 7% compounded monthly:1,00,000×(1+0.07/12)12≈₹1,07,2291,00,000×(1+0.07/12)12≈₹1,07,229
Online Tools: Many investment platforms and mutual fund websites like Groww, Zerodha, and Moneycontrol offer free arbitrage calculators.
Tips to Maximize Returns from Arbitrage Funds
Invest in volatile markets, when spreads are high.
Stay invested for more than 1 year to enjoy long-term tax benefits.
Compare expense ratios – lower charges mean better net returns.
Monitor the fund’s performance on a quarterly basis, especially if it is being used as a short-term option.
Taxation on arbitrage funds
For taxation, arbitrage funds fall under the category of equity-oriented mutual funds, which affects how gains from them are taxed:
- Short-Term Capital Gains (STCG): Taxed at 15% if sold within 12 months.
- Long-Term Capital Gains (LTCG): Taxed at 10% (if gain exceeds ₹1 lakh in a financial year) after 12 months.
This tax treatment gives arbitrage funds an edge over traditional debt or fixed deposits, especially for investors in higher tax brackets.
Conclusion
So, what is an arbitrage fund? It is a low-risk, short-term investment option that profits from price differences in the market. The meaning of arbitrage fund is simple: it is a smart way to earn steady returns without taking full equity market risk.
Whether you are a beginner or a conservative investor, arbitrage funds can be a valuable addition to your portfolio. Use tools like the arbitrage calculator to estimate your returns and make better decisions. And remember – while arbitrage funds are safer than pure equities, it is still important to track performance and invest according to your financial goals.
FAQs
Q1. Are arbitrage funds safe?
A: They’re low-risk but not risk-free. Returns depend on market inefficiencies.
Q2. Arbitrage vs. Debt Funds: Which is better?
A: Arbitrage funds offer tax advantages for <3-year holdings; debt funds suit longer terms.
Q3. Is there a lock-in period?
A: No, but exit loads may apply if redeemed within 15–30 days.
Q4. Who should invest?
A: Conservative investors seeking equity-like taxation with lower risk.