According to AMFI data released in May 2026, the arbitrage mutual funds category received inflows of Rs. 12,378 crores in April. The inflows were higher than those received by individual hybrid and equity schemes in April. The arbitrage funds category has total assets under management (AUM) of Rs. 2.70 lakh crores as on 30th April 2026. In this article, we will understand what arbitrage mutual funds are, how they work, the returns delivered, and their taxation.
What are arbitrage mutual funds?
In general terms, the word ‘arbitrage’ means taking advantage of different prices for the same product in two different places. For example, when buying clothes or personal accessories, we often compare prices between two different offline shops or between online and offline merchants. Sometimes we compare the prices of electronics like laptops and mobile phones in India and the US. Some people compare gold prices in India with those in foreign markets like Dubai.
Similarly, arbitrage funds also take advantage of the difference in prices of an equity security in two different markets. We, as individuals, compare prices in two different markets and buy where the price is lower. Arbitrage funds go one step further. They buy from the market where prices are lower and simultaneously sell in the market where prices are higher.
The difference in the price of the equity security in the two markets is known as the spread. Arbitrage mutual funds lock in this spread as profit. For example, suppose the shares of Company A are trading at Rs. 100 per share in the cash market and at Rs. 105 per share in the futures market.
An arbitrage fund buys the security from the market where the price is lower. In this case, the fund will buy shares of Company A at Rs. 100 from the cash market. Simultaneously, the fund sells the security in the market where the price is higher. In this case, the arbitrage fund will sell Company A futures at Rs. 105. In the process, the arbitrage fund will lock in a profit of Rs. 5 per share.
Please note that the Rs. 5 per share is the gross profit. The fund has to account for brokerage costs, depository charges, SEBI and Government levies, and any other charges involved. What remains after accounting for all the charges is the net profit.
Let us look at the various scenarios on the expiry date.
- Company A shares close at Rs. 95 in the cash market
In this case, the arbitrage fund will incur a loss of Rs. 5 per share on the shares bought from the cash market. It will make a profit of Rs. 10 per share on the shares sold in the futures market. After considering the Rs. 10 per share profit in the futures market and the Rs. 5 per share loss in the cash market, the overall gross profit will be Rs. 5 per share.
2. Company A shares close at Rs. 100 in the cash market
In this case, the arbitrage fund will not make any profit or loss on the shares bought from the cash market. It will make a profit of Rs. 5 per share on the shares sold in the futures market. After considering the 5 per share profit in the futures market and the no profit or loss in the cash market, the overall gross profit will be Rs. 5 per share.
3. Company A shares close at Rs. 105 in the cash market
In this case, the arbitrage fund will make a profit of Rs. 5 per share on the shares bought from the cash market. It will not make any profit or loss on the shares sold in the futures market. After considering the Rs. 5 per share profit in the cash market and no profit or loss in the futures market, the overall gross profit will be Rs. 5 per share.
Thus, irrespective of the cash market closing price on expiry (whether it is the same, higher, or lower than the purchase price), the profit of Rs. 5 per share remains the same. In this manner, arbitrage funds lock in gains by simultaneous buying and selling the same security in two different markets.
In the earlier example, we saw how an arbitrage fund makes money by buying at a lower price in the cash market and selling at a higher price in the futures market. Similarly, arbitrage opportunities can arise from pricing discrepancies on different stock exchanges.
For example, suppose shares of Company A are trading at Rs. 100 on the NSE and at Rs. 105 on the BSE. In this case, an arbitrage fund can buy Company A shares at Rs. 100 on the NSE and sell them at Rs. 105 on the BSE, making a profit of Rs. 5 per share.
Returns delivered by arbitrage funds
Let us look at the average returns delivered by the arbitrage funds category.
Investment tenure | Returns (%) |
1-year | 5.60 |
3-years | 6.65 |
5-years | 5.74 |
Source: Value Research Online
The above returns are as of 5th June 2026. The 1-year returns are absolute. The 3 and 5-year returns are CAGR. As arbitrage funds take advantage of price differences, which are more likely during periods of volatility, they may do well in volatile markets.
Taxation of arbitrage funds
As per SEBI regulations, an arbitrage fund must invest at least 65% of its total assets in equity and equity-related instruments. The remaining up to 35% can be in debt instruments. Since an arbitrage fund has at least 65% exposure to equity instruments, it is treated as an equity fund for taxation purposes. The taxation is as follows.
- Short-term capital gains tax
When arbitrage fund units are sold within 12 months from the purchase date, the profit is categorised as short-term capital gain (STCG). The STCG is taxed at a flat rate of 20%.
2. Long-term capital gains tax
When arbitrage fund units are sold after 12 months from the purchase date, the profit is categorised as long-term capital gain (LTCG). The first ₹1.25 lakhs LTCG in a financial year is exempt from taxation. The incremental LTCG in a financial year is taxed at a flat rate of 12.5%.
So, while arbitrage funds give annual returns that are usually in the 5 to 7% range and compare to debt funds, they are tax-efficient as they are taxed as equity funds.
Who invests in arbitrage funds?
Arbitrage funds are suitable for investments for a short tenure. Investors who don’t want to take too much risk and are content with returns in the 5–7% p.a. range can consider them. Some investors in higher tax brackets consider arbitrage funds, as they are tax-efficient.
Some investors consider arbitrage funds for parking emergency funds, while some consider them for parking a lumpsum amount for a systematic transfer plan (STP) into an equity fund. If you want to invest in an arbitrage fund, consult a financial advisor who can recommend the appropriate fund based on your financial needs.