Speaking to CNBC-TV18, Gang said, “30 to 35 basis points is considerably high when you compare the category along with your liquid and other debt funds, because arbitrage as a category primarily is used by investors to park their short-term money. So, it’s a considerable hit, considering what you were getting in liquid post tax, and now what you will get in arbitrage post tax.”
The impact would be particularly higher given the sharp rise in trading costs in the futures segment following the STT hike. Arbitrage funds typically generate returns by buying stocks in the cash market and selling them in the futures market, making transaction costs a key determinant of performance.
Gang noted that arbitrage funds have grown rapidly in recent years and now form a sizable segment of the mutual fund industry, with assets under management of nearly ₹3.50 lakh crore. As the category has scaled up, even small changes in trading costs can have a meaningful impact on investor returns.
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Despite the compression in returns, Gang said arbitrage funds continue to offer a post-tax advantage over liquid funds, particularly for investors in higher tax brackets. While the differential has narrowed following the STT hike, arbitrage funds still benefit from equity-like taxation when held for more than a year.
“The return differential between arbitrage and liquid is still in favour of arbitrage. The margin of difference has squeezed quite a lot from a previous margin of 1.23% it has come down to around 90 basis points.”
He added that arbitrage funds are likely to remain a preferred choice for short-term parking of surplus funds, especially when compared with savings accounts and most debt fund categories, though investors should moderate return expectations in the new cost environment.
For investors whose time horizons extend beyond the short term, Gang advised a strategic shift into hybrid funds. He outlined a ‘ladder’ of options based on risk appetite and investment duration.
For a tenor of one to three years, an equity savings or conservative hybrid fund would be suitable. For longer periods, stretching towards five years, investors could consider balanced advantage, multi-asset, or aggressive hybrid funds.
However, he also noted that for those preferring to stay within the fixed income space, arbitrage funds might still offer better returns than most debt categories, barring specific credit risk or corporate bond funds.
For the entire discussion, watch the accompanying video
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