Arbitrage Funds Can See Up To 20-30-Basis-Point Reduction In Returns, Say Mutual Fund Experts

However, investment advisers say the impact is unlikely to dent the attractiveness of the category, especially from a post-tax perspective.

Arbitrage funds, which primarily aim to capture price differentials between the cash and futures markets, currently manage assets worth Rs 2.78 lakh crore as of December 31, 2025. The category’s assets under management have grown nearly four times over the last three years, reflecting strong investor preference for low-risk, tax-efficient investment options.

How STT Hike Impacts Arbitrage Fund Returns?

Arbitrage funds typically buy stocks in the cash market while simultaneously selling futures contracts to lock in spreads. Since these positions are rolled over frequently and executed at scale, even a marginal increase in transaction costs, such as higher STT can eat into returns. Experts point out that while the impact may appear small in absolute terms, the cumulative effect over multiple trades can lead to a measurable decline in annualised returns.

Should Investors Still Consider Arbitrage Funds?

Despite the expected reduction in returns, mutual fund participants continue to recommend arbitrage funds, particularly for investors in higher tax brackets and those seeking short-term parking of funds.

Ashish Somaiyaa, CEO of White Oak Capital AMC, says higher transaction costs will weigh on returns, as arbitrage funds typically hold long positions in the cash market and short positions in the futures market. However, he adds that post-tax returns are still likely to be superior to most fixed-income products, which offer lower yields

Suresh Sadagopan, founder of Ladder7 Wealth Planner, notes that arbitrage funds are generally recommended for investors looking for short-term liquidity ranging from three to six months or up to one year. He adds that the category remains attractive due to its high liquidity and favourable tax treatment, as arbitrage funds are taxed like equity funds.

According to Vishal Dhawan, CEO of Plan Ahead Wealth Advisors, arbitrage funds continue to be a preferred option for investors in higher tax brackets both retail and high-net-worth investors. He says the net tax advantage over debt funds which is closest alternatives to arbitrage funds, particularly liquid and short-term debt schemes, remains intact, while the risk profile stays relatively low.

Santosh Joseph, partner at Germinate Investor Services, points out that most arbitrage funds vary in their portfolio construction and  the percentage of arbitrage is different for different funds, which may vary the returns. While gross yields for the category may have softened, post-tax, in-hand returns continue to compare favourably with traditional fixed-income products, which have high taxes especially after capital gains tax was removed from fixed income.

Arbitrage Fund Performance, AUM trend

Source: AMFI

Bottom Line

While the proposed STT increase is expected to marginally compress arbitrage fund returns, advisors believe the core value proposition of equity tax efficiency, liquidity, and low risk remains unchanged. For investors looking to park short-term surplus funds especially those in higher tax brackets arbitrage funds are likely to remain a relevant investment option.

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