What is an Arbitrage Fund? Meaning, Strategy & Returns

Arbitrage funds are low-risk mutual funds that make money from price differences in the same asset in two markets. They buy in one market and sell in another to earn a small profit. Returns change with market conditions.

‘Bhaiya sasta aur sabse acha dikhaiye!’

We middle-class folks love value for money, and we crave comfort, but only within our budget.

That’s why we believe in a special category of investment: one that’s low on risk and steady on returns. Arbitrage funds effortlessly fit into this description.

For example, Raghav invested ₹2,00,000 in an arbitrage fund in 2023. He didn’t want to take big risks, but also didn’t want to leave his money bank account. His fund bought shares in the cash market and sold them in the futures market. The price difference was the profit. He earned around a 5% return that year, all with low risk.

The table below summarises his finances related to the arbitrage fund.

If this example has intrigued you, this blog is made for you. We have explained what arbitrage funds are, how they work and how safe they are for you.

What Are Arbitrage Funds?

Ever been to a village fair? Let’s teleport you to one for a few minutes. There, you see one stall selling mangoes for ₹80/dozen and two stalls down, another is buying mangoes at ₹90/dozen. You quickly buy from the first and sell to the second, gaining ₹10 per dozen.

That’s exactly how arbitrage funds work in the stock market. They spot these small price gaps between two markets (cash and futures). They buy low, sell high, at the same time, and give you small, safe profits. 

Just like that mango seller, arbitrage funds profit from similar price differences. But to ensure investor safety, SEBI has laid down some rules. It has mandated that at least 65% of the portfolio is in equity or related securities, with the rest in debt. This makes it a market-neutral, low-risk hybrid product. 

How the Arbitrage Fund Strategy Works?

Fund managers scan for price mismatches. They buy shares at a lower price and sell them at a slightly higher price in the futures market. This synchronised “cash and carry” trade earns a consistent yield, typically contributing 5–7% annual returns.

Let’s understand it with the help of an example.

For example, in May 2025, Tisha Industries was trading at:

• ₹1,272.30 in the cash market (spot price)
   
• ₹1,280.40 in the futures market (for next-month expiry, i.e., 41 days later)

An arbitrage fund notices this price difference and buys 500 Tisha shares in the cash market at ₹1,272.30. It further sells 1 futures contract (equivalent to 500 shares) at ₹1,280.40. This means there is a net gain of ₹4,050. Let’s break down the numbers with the help of the given table.
 

This ₹8.10 per share is a guaranteed spread. That means the fund earns this regardless of how the market moves.

But how is there no market risk? Well, it’s because of the following:
 

• If Reliance drops to ₹1,260 by expiry, the futures will also drop, say, to ₹1,268.30. You still earn the same ₹8.10 spread.
   
• If Reliance rises to ₹1,290, futures might rise to ₹1,298.10. Again, you gain a stable difference of ₹8.10.

What You Gain and What You Lose?

Before going with any investing option, evaluate what is in it for you. A high-return option can never be an ideal one. Arbitrage funds may not be for your cousin, but can be for you!

Benefits

1. Low risk and market-neutral: Arbitrage funds earn from price differences and not market movements. So they carry very little risk, even in volatile markets. 
    
2. Equity-like taxation: Gains held for >1 year are taxed at 10% LTCG (first ₹1,00,000 exempt). If the period is less for example, ≤12 months, it is taxed at 15% STCG. It is often more tax-efficient than debt funds for higher earners.
    
3. High liquidity and flexibility: These funds have no lock-in period, so you can invest or withdraw at any time without penalties.

Risks

1. Lower returns in stable markets: When market volatility is low, price differences shrink and reduce potential profits. Sometimes, it is even below savings rates.
    
2. Expense ratio can reduce profits: Annual charges between 0.3% to 0.7% may nullify your already modest returns.
    
3. Depends on smooth execution and debt quality: Delays in trade settlement or poor-quality debt holdings can affect returns and reduce NAV.

Returns Overview

Arbitrage funds are like those quiet, mediocre students in class. They do not show off much, but they are always scoring better than expected. We don’t just say anything without proper data. Let’s check out how these funds have been winning across timeframes in the table below! 
 

These figures show that arbitrage funds consistently return between 6–8% over one to five years.
With this verified data, we can easily say that Arbitrage funds are better than bank FDs, and short-term debts, and they also save on taxes. This is because:

1. Bank FDs typically give 6.1–7.4%.
    
2. Short-term debt funds return 8–10%, but the effective post-tax yield may be similar to arbitrage after equity taxation.
    
3. Arbitrage funds, with a stable 7–8%, win on tax efficiency and liquidity.

Follow These Tips To Choose The Best Arbitrage Fund

Not all seasons can reap mangoes; similarly, not all arbitrage funds are created equal. If you want stable returns with low risk, you need to check a few things before investing. Here's a simple way to pick the right fund, with real examples.

1. Check 3–5 Year Returns (Target: 6–7%)

The best arbitrage funds give consistent returns over 3-5 years. This shows they’ve managed well through different market phases. Avoid funds that are high one day and depressed the other. Also, don’t go for consistent <6% returns. 

For example, Ravi invested ₹1,50,000 in the XYZ Equity Arbitrage Fund in 2020. Over 3 years, he earned stable annualised returns of 7.73%. That means his total gains would be ₹37,000+. 

Here’s how 3 years went through:
 

Ravi didn’t track the market daily, yet he was able to see healthy growth. You just need to pick a steady performer rather than the one that gives higher returns.

2. Look at the Expense Ratio (Keep it <0.5%)

The expense ratio is the fee the fund charges every year. A lower ratio means more money stays in your pocket. Try to choose funds with an expense ratio under 0.5%. Anything higher is not good for your returns.

For example, Meena compared two similar funds: one with 0.39% expense and one with 0.69%. Over 3 years, the cost difference alone cost her ₹2,300 in missed returns.
 

‘Sasta bhi, Sabse acha bhi!’ By just choosing the most cost-efficient one, Meena earned ₹1,836 more. See that’s what a 0.11% can do! 

3. Check Fund Size and Liquidity

Funds with larger AUM (assets under management) are more liquid. You can enter and exit without issues. A large fund also shows investor trust. Ideally, pick a fund with AUM over ₹10,000 crore for better flexibility.

For example, Arjun needed ₹50,000 urgently. Since he invested in Kotak Arbitrage (AUM ₹67,000+ cr), his withdrawal was processed in a day. A smaller fund he once used had delayed payouts for 3 days.  Larger AUM funds usually maintain better cash buffers, enabling quicker redemptions and a smoother investor experience

Conclusion

Arbitrage funds are low-risk, tax-savvy, and make you money, almost always. They don’t give high returns, but they deliver like clockwork. If you love ‘sasta aur sabse achha,’ this is your jam. Pick smart, watch expenses, and let these funds hustle while you chill. Win-win!

Frequently Asked Questions

Are arbitrage funds suitable during bull or bear markets?
They are relatively neutral to market direction. Arbitrage funds perform better during volatile markets with frequent price differences.

Can NRIs invest in arbitrage funds?
Yes, NRIs can invest in arbitrage funds in India, subject to KYC and FEMA regulations.
 

What returns can investors expect?
Typically 6–8% annualised in India. It further depends on market spreads and fund efficiency.
 

How are taxes applied?
Taxed as equity: STCG (<12 months) at 15%, LTCG (>12 months) at 10% above ₹1,00,000 gain.
 

Are they low-risk?
Generally low volatility due to hedging, but returns vary with arbitrage opportunities and fund expense structure. 

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