Arbitrage Funds: Meaning, Returns & Taxation

A share can have one price in the cash market and another in the futures market. Arbitrage funds aim to earn from this difference through matching positions in both markets. Their strategy focuses on the price gap rather than relying on rising share prices. Understanding how it works can help you assess the fund’s returns, taxation and role in your portfolio.

What is an arbitrage fund?

An arbitrage fund is a mutual fund that seeks returns from price differences between related investments, commonly a share and its futures contract.

The arbitrage fund meaning comes from “arbitrage”, a strategy that uses price differences between markets to seek a return. These funds typically combine cash-market purchases with corresponding futures sales to reduce exposure to share-price movements.

SEBI classifies arbitrage funds under hybrid schemes and requires at least 65% of total assets to be invested in equity and equity-related instruments. Other investments must follow the applicable regulations and scheme mandate.

Sources: SEBI Investor, “Arbitrage Mutual Fund”; SEBI, Master Circular for Mutual Funds, 20 March 2026, arbitrage fund category.

Key Takeaways

Arbitrage mutual funds seek returns from price differences, commonly between cash and futures markets.
Matching positions help reduce exposure to the direction of share-price movements.
Returns depend on available spreads, portfolio management and costs.
Qualifying equity-oriented arbitrage funds receive equity mutual fund tax treatment.
Hedging does not guarantee returns or prevent short-term NAV fluctuations.

How do arbitrage funds work?

The fund manager looks for a price difference, or spread, that remains worthwhile after trading costs.

For example, if a share trades at ₹200 and its futures contract trades at ₹202, the fund can buy the shares and sell an equivalent futures position.

A rise in the share price benefits the cash holding but works against the sold futures position. A fall has the opposite effect. This pairing helps offset directional price movements.

A simple arbitrage fund example

Assume the fund buys 1,000 shares at ₹200 each and sells a futures position representing the same quantity at ₹202.

Suppose both positions are later closed when their prices converge at ₹205:

Position	Calculation	Gross result
Shares purchased at ₹200 and sold at ₹205	₹5 × 1,000 shares	₹5,000 gain
Futures sold at ₹202 and bought back at ₹205	−₹3 × 1,000 shares	₹3,000 loss
Combined result	₹5,000 − ₹3,000	₹2,000 gain

The combined result captures the original ₹2 spread per share.

The example assumes matching quantities and execution at the stated prices. It excludes trading costs, taxes, margin-funding costs and fund expenses. The result illustrates one trade, not the return received by a mutual fund investor.

The figures shown are for illustrative purpose only.

Sources: SEBI Investor, “Understanding Derivatives” and “Arbitrage Mutual Fund”, cash–futures arbitrage explanations.

What affects arbitrage fund returns?

Arbitrage fund returns depend on the opportunities available and the costs of capturing them:

Size of the spread: A wider cash–futures price difference may provide more scope to earn after costs.
Available opportunities: The fund needs suitable trades and sufficient liquidity to establish matching positions.
Interest rates: Cash–futures spreads often reflect financing costs and prevailing money market rates.
Expenses: Trading costs and the expense ratio reduce returns.
Other holdings: Debt and money market investments also contribute to portfolio performance.

When reviewing historical returns, compare the same period, plan and option against the relevant benchmark.

Past performance may or may not be sustained in future.

Does market volatility improve returns?

Volatility can change cash–futures spreads and create opportunities, but it does not automatically produce higher returns. The spread still needs to be attractive after costs, and the fund must be able to execute both positions. Their values can also move differently before they converge or are closed, causing short-term NAV fluctuations.

How does arbitrage fund taxation work?

An arbitrage fund that qualifies as an equity-oriented mutual fund receives the applicable equity-fund tax treatment. Its classification as a hybrid scheme does not, by itself, determine taxation.

The following rates apply to qualifying equity-oriented fund units, subject to applicable securities transaction tax conditions:

Type of gain	Holding period	Tax treatment
Short-term capital gains	12 months or less	20%
Long-term capital gains	More than 12 months	12.5% on aggregate qualifying LTCG exceeding ₹1.25 lakh in a tax year

Surcharge and cess may also apply.

The ₹1.25 lakh threshold covers aggregate qualifying long-term gains across relevant assets, including equity shares and equity-oriented funds. It is not a separate exemption for each fund.

For SIP investments, each instalment has its own holding period. IDCW distributions are taxable in the investor’s hands and are generally taxed at the applicable slab rate for resident individuals.

Sources: Income Tax Department, capital-gains guidance; Income-tax Act, 2025

Tax treatment can affect your post-tax return, but it does not automatically make an arbitrage fund preferable to a deposit or debt fund. Compare the actual return, costs, holding period and your tax position.

The tax information in this article is based on prevailing laws at the time of publishing the article and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.

What are the benefits and risks of arbitrage funds?

Arbitrage funds offer a hedged investment approach, with benefits and limitations to consider:

Benefits

The arbitrage strategy offers the following benefits:

Reduced directional equity exposure: Matching cash and futures positions aim to offset share-price movements.
Professional management: The fund manages trade selection, execution and settlement.
Equity-oriented taxation: Qualifying schemes receive the applicable equity-fund tax treatment.

Risks and limitations

Returns can still be affected by market conditions, trade execution and costs:

Changing opportunities: Narrower spreads can reduce the scope to earn after costs.
Short-term fluctuations: NAV can change while matching positions remain open.
Execution and liquidity: Difficulty completing or closing trades can affect results.
Other portfolio risks: Debt and money market holdings carry risks associated with their underlying instruments.
Exit costs: An applicable exit load can reduce proceeds from an early redemption.

Hedging reduces particular exposures; it does not make the entire fund risk-free.

Arbitrage funds versus liquid funds

Both categories may be considered for surplus money, but their investment approaches and taxation differ:

Factor	Arbitrage funds	Liquid funds
Main approach	Seek returns from arbitrage opportunities, commonly cash–futures spreads	Invest in debt and money market securities with maturities of up to 91 days
Return drivers	Spreads, execution, other holdings and expenses	Interest income, security-price changes and expenses
Equity exposure	Typically hedged through corresponding positions	Primarily debt and money market exposure
Capital-gains taxation	Equity-fund treatment where the scheme qualifies	For units covered by the specified mutual fund rules and acquired on or after 1 April 2023, gains are treated as short-term and generally taxed at applicable slab rates for resident individuals
Important checks	NAV fluctuations, expenses, exit load and redemption timelines	Credit quality, expenses, exit load and redemption timelines

Neither category guarantees returns. Compare access requirements and the amount retained after costs and taxes.

Sources: SEBI, Master Circular for Mutual Funds, arbitrage category; AMFI, liquid-fund classification; Income-tax Act, 2025, Section 76, specified mutual fund provisions.

Who should consider an arbitrage fund?

An arbitrage fund may be worth assessing if you have surplus money, prefer hedged equity exposure and can accommodate short-term fluctuations.

Before selecting a scheme, check:

Access needs: Match your payment date with redemption processing and exit-load terms.
Risk tolerance: Assess whether fluctuations in value fit your circumstances.
Costs: Compare expense ratios for corresponding plans.
Portfolio and Riskometer: Review current disclosures to understand the scheme’s investments and risk level.
Post-tax outcome: Consider your holding period and applicable tax treatment.

There is no universal holding period that makes every arbitrage fund suitable. Money needed immediately requires particular attention to access and potential changes in value.

How to invest in arbitrage mutual funds

Complete or validate your KYC, select a scheme and choose its plan and investment option. You can invest through the fund house or an authorised distributor, using a one-time investment or an SIP where available. Direct and regular plans share the same portfolio but have different expense ratios. Before confirming, check the selected plan, option, amount and applicable scheme terms.

Sources: AMFI, KYC requirements and direct-plan guidance; Bajaj AMC, official arbitrage fund investment facilities.

Explore Bajaj Finserv Arbitrage Fund

Bajaj Finserv Arbitrage Fund seeks returns from arbitrage opportunities in the cash and derivatives segments of equity markets, with the balance invested in debt and money market instruments.

Its portfolio strategy aims to maintain fully hedged equity positions. You hold mutual fund units while the fund manages the underlying trades.

The scheme’s benchmark is the Nifty 50 Arbitrage Index (TRI). Review its performance against that benchmark, together with the latest portfolio, Riskometer, expense ratio and exit load.

SIP and one-time investment facilities are available, subject to scheme terms and KYC requirements. Achievement of the investment objective is not assured.

Sources: Bajaj AMC, official Bajaj Finserv Arbitrage Fund page, portfolio strategy and scheme investment objective.

Conclusion

Arbitrage funds seek returns from price differences through matching investment positions. Understanding arbitrage fund returns, taxation, costs and redemption terms helps you assess their role in your portfolio. Choose an arbitrage mutual fund around your access needs and comfort with fluctuations, rather than expecting a fixed return.

FAQs

Is an arbitrage fund an equity fund or a debt fund?

SEBI places arbitrage funds in the hybrid category. A qualifying scheme can receive equity-oriented tax treatment. The term equity arbitrage fund describes its equity-based arbitrage approach, rather than a separate SEBI category.

Can arbitrage funds give negative returns?

Yes, particularly over short periods. Changes in spreads, portfolio valuations and costs can affect NAV despite the hedged strategy.

Are arbitrage funds tax-free?

No. Gains and distributions are subject to applicable tax rules. Qualifying equity-oriented schemes receive equity-fund capital-gains treatment.

Are arbitrage fund returns fixed?

No. Available spreads, portfolio performance and expenses affect returns. Historical performance does not establish a fixed rate for future investments.