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What if there was a way to take advantage of stock market volatility without putting your capital at risk? What if you could earn debt mutual fund-like returns without exposure to credit, default, or duration risks? What if there was an equity product that offered the safety of capital protection while delivering steady, debt-like returns?

If these questions pique your interest, it’s time to explore one of the best-kept secrets of the Indian mutual fund industry: the Arbitrage fund.

While savings accounts yield as little as 2.70% per annum, schemes like the Baroda BNP Paribas Arbitrage Fund have delivered 7.15% returns for investors over the past year (see table below). With ongoing stock market volatility, arbitrage funds are poised to capitalize on pricing mismatches between cash and futures markets, offering investors relatively risk-free returns. High volatility in stock markets throw up opportunities for arbitrage fund managers to unwind trades at a profit say fund managers. With the markets having entered such a phase for more than a quarter now, arbitrage funds are emerging as the heroes of investors waiting on the sidelines to deploy cash for long term investments.

* As of 31 January 2025 Source: bankbazaar.com @ Interest rates are for regular savings bank accounts

Arbitrage funds offer higher, relatively risk-free returns, especially beneficial for investors in the 22% and 33% tax brackets. These funds are eligible for the same concessional tax rate as that applicable to equity funds i.e.—20% for short-term gains and 12.5% for long-term gains without indexation—making them an attractive choice for tax-efficient investing.

Why Arbitrage Funds Are Gaining Popularity

Arbitrage funds have become a popular choice for tax-savvy investors, offering tax-adjusted returns. This growing interest has driven the category's AUM to Rs 2 trillion, nearly tripling since April 2023. According to the December 2024 AMFI report, there are 31 arbitrage schemes with a total of 5.73 lakh investor folios in the category.

This growth is supported by an increase in open interest in stock futures, and the tax benefits of arbitrage funds. FIIs’ steady equity sales have also widened the spreads between cash and futures markets, creating more opportunities for arbitrage funds. Funds like the Baroda BNP Paribas Arbitrage Fund focus on spread opportunities in smaller companies while adhering to regulatory limits.

Liquidity and Ease of Access

Investors can redeem their investments from arbitrage funds with zero exit load after 15 days. The redemption proceeds are credited to bank accounts the next business day, offering both convenience and liquidity.

For those looking for an alternative to idle bank balances, arbitrage funds can be a profitable consideration in volatile markets say financial planners.

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