Arbitrage funds: Attractive option for parking short-term money

In March 2023, the asset under management (AUM) of arbitrage funds stood at Rs. 67,435.21 crore. By the end of June 2025, it had increased to Rs. 2,49,364.93 crore, a 3.7x increase.

- By: Sudipta Mitu

Reasons for popularity

In April 2023, the government withdrew indexation benefits for debt funds, making their taxation less attractive. Arbitrage funds enjoy equity-like taxation, giving them a post-tax return edge over traditional debt funds. This tax advantage spurred a sharp increase in flows.

Arbitrage strategies thrive on market volatility. The past year saw periods of heightened volatility in the equity market, which created more pricing inefficiencies for funds to exploit.

Amid economic uncertainty, many investors sought out safe havens. Arbitrage funds maintain market-neutral (hedged) positions, so they carry much lower risk than pure equity funds. This relative stability, combined with better post-tax yields, has drawn in those looking to park short-term money safely.

How do they make money?

Arbitrage funds generate returns by exploiting price differentials between markets or segments of the same underlying asset. The most common strategy is cash-futures arbitrage on stocks.

Fund managers simultaneously buy a stock in the cash (spot) market and sell it in the futures market if the futures price is higher. This locks in a spread (profit) at initiation. For example, if a stock trades at ₹1,000 in the cash market and its one-month futures contract is ₹1,010, the fund buys the stock and short-sells the future. The fund captures the ₹10 difference (minus transaction costs) as risk-free profit.

Advantages of arbitrage funds

Arbitrage funds are designed to be low-risk investments. As each stock position is hedged by an opposite position, the fund has virtually no net exposure to market swings. Unlike typical equity funds, arbitrage funds don't suffer if the market falls.