Definition of Arbitrage Fund
An arbitrage fund is a type of equity hybrid mutual fund that generates returns by simultaneously buying and selling the same stock in different markets (cash and futures) to exploit price differences. Because each position is hedged with an opposite position, the fund has very low market risk.
Since arbitrage funds maintain at least 65% of their portfolio in equity (even though they are hedged), they qualify for equity fund taxation: LTCG of 12.5% if held for more than 1 year, and STCG of 20% if held for less. This tax treatment is significantly better than debt funds or FDs for investors in the 30% tax bracket.
Returns from arbitrage funds typically mirror short-term interest rates (6–7% p.a.) because arbitrage opportunities in liquid markets are quickly closed. They are ideal for parking large amounts (₹5 lakh+) for 6–12 months where you want equity taxation benefits and slightly better returns than liquid funds, without taking market risk.