Best Arbitrage Mutual Funds in India (2026)

What Are Arbitrage Mutual Funds and How Do They Work?

Arbitrage mutual funds are hybrid mutual fund schemes that seek to profit from pricing differences between different segments of the stock market.

The fund manager usually:

• Buys a stock in the cash (spot) market
• Sells the corresponding futures contract

This locks in the price difference between the two markets. The positions are generally held until the futures contract expires.

Because the equity positions are typically hedged using derivatives, the portfolio has limited exposure to overall market direction.

Returns depend on the availability of arbitrage opportunities and market liquidity.

SEBI's Classification Rule for Arbitrage Mutual Funds

Under SEBI’s mutual fund categorisation framework, arbitrage funds fall under the hybrid scheme category.

Key regulatory requirements include:

• Arbitrage funds must maintain at least 65% exposure to equity and equity-related instruments
• Equity exposure is typically hedged using derivatives such as futures contracts
• The remaining portion is generally invested in short-term government securities, treasury bills, repos, or other money market instruments
• Each asset management company (AMC) can offer only one scheme in the arbitrage fund category

Maintaining more than 65% equity exposure qualifies arbitrage funds for equity-oriented taxation.

How Do Arbitrage Mutual Funds Generate Returns?

Arbitrage mutual funds generate returns primarily from arbitrage spreads and short-term debt investments.

• Arbitrage spread

The fund buys stocks in the cash market and sells equivalent futures contracts. The price difference between the two markets creates the arbitrage opportunity.

• Debt and money market income

The portion of the portfolio not deployed in arbitrage opportunities is usually invested in short-term debt instruments such as treasury bills, government securities, or money market instruments.

Returns depend on the availability of price spreads and market conditions.

Who Should Invest in Arbitrage Mutual Funds?

Arbitrage mutual funds may be suitable for investors seeking relatively stable short-term returns with equity taxation.

They may be appropriate for:

• Investors looking to park funds temporarily before investing in equities
• Investors in higher tax brackets seeking equity-oriented taxation
• Investors with a short-term investment horizon of around 3–12 months

Investors should consider their financial goals, investment horizon, and risk tolerance before investing.

Arbitrage Funds vs Liquid Funds

Arbitrage funds and liquid funds are both used for short-term investments, but they differ in strategy and taxation.

Arbitrage funds generate returns from price differences between the cash and futures markets, while liquid funds invest in short-term debt instruments with maturities of up to 91 days.

Because arbitrage funds maintain at least 65% equity exposure, they are taxed as equity-oriented funds. Liquid funds are debt funds taxed according to the investor’s income tax slab.

Benefits of Arbitrage Mutual Funds

Arbitrage funds offer several structural features that distinguish them from other mutual fund categories.

• Equity-oriented taxation

Because the portfolio maintains more than 65% equity exposure, arbitrage funds are taxed as equity funds.

• Limited exposure to market direction

The equity positions are typically hedged using derivatives, which reduces exposure to broad equity market movements.

• Short-term investment option

These funds are often used by investors looking for alternatives to short-duration or liquid funds with different tax treatment.

Risks of Arbitrage Mutual Funds

Arbitrage mutual funds also involve certain risks.

• Arbitrage opportunity risk

Returns depend on the availability of price differences between the cash and futures markets.

• Interest rate risk

The debt portion of the portfolio may be affected by changes in interest rates.

• Expense ratio impact

Active trading and portfolio management may increase the cost of managing the fund.

• Lower return potential compared with equity funds

Since the strategy focuses on capturing small price differences, returns may be lower than diversified equity mutual funds over long periods.

Investors should consider these risks before investing.