Arbitrage funds beat bank FDs with higher returns amid market volatility

Amid continuous market volatility, arbitrage funds have surpassed public bank fixed deposits (FDs) in terms of one-year returns

Top 10 arbitrage funds: Higher returns amid stock market volatility

 

In a climate of heightened volatility, the stock market has caused concern among investors. From February 10 to February 14, the benchmark indices—Sensex and Nifty—declined by approximately 2.5 per cent, marking the most significant weekly drop of 2025 so far. Amid these fluctuations, arbitrage funds have demonstrated resilience, outperforming fixed deposits (FDs) from public banks over the past year.

 

According to data from the Association of Mutual Funds in India (Amfi), arbitrage funds have yielded returns exceeding 7 per cent in the last year, while most public bank FDs offered interest rates below this threshold during the same period. This performance highlights the potential of arbitrage funds as a viable investment alternative in uncertain market conditions.

 

Top 10 arbitrage funds: Delivered over 7 per cent returns in one year

 

Amid continuous market volatility, arbitrage funds have surpassed public bank FDs in terms of one-year returns.

 

According to Amfi data, the top ten arbitrage funds generated returns of 7-8 per cent over the last year. During the same period, however, most public bank FDs offered interest rates below 7 per cent.

 

Paisabazaar's list of one-year FD interest rates shows that SBI, PNB, Union Bank of India, and Bank of India all offer 6.8 per cent interest on one-year FDs.

 

Among the top ten arbitrage funds, Kotak Equity Arbitrage Fund returned the highest at 7.59 per cent, while Union Arbitrage Fund yielded the lowest at 7.32 per cent over the past year.

 

Here is the list of the top ten arbitrage funds based on their one-year performance:

 

S No.	Arbitrage Fund Name	1 Year Return (Fig in %)
1	Kotak Equity Arbitrage Fund	7.59
2	UTI Arbitrage Fund	7.5
3	HDFC Arbitrage Fund	7.47
4	Invesco India Arbitrage Fund	7.44
5	ICICI Prudential Equity Arbitrage Fund	7.43
6	Edelweiss Arbitrage Fund	7.4
7	SBI Arbitrage Opportunities Fund	7.37
8	Bandhan Arbitrage Fund	7.35
9	Axis Arbitrage Fund	7.34
10	Union Arbitrage Fund	7.32

 

Source: AMFI (Based on NAV as of January 14, 2025)

  What is an arbitrage fund?

 

According to Amitabh Lara, executive director and unit head – Mumbai, Anand Rathi Wealth Limited, arbitrage funds are a type of hybrid fund that capitalises on price differences between the cash (spot) market and the futures market, as well as discrepancies in security prices across different stock exchanges.

 

Their performance depends on the availability of arbitrage opportunities, the fund manager's expertise, and their yields, which are somewhat influenced by market conditions.

 

How to benefit from market volatility?

 

Investors do not need to panic amid market fluctuations, as they can take advantage of volatility by investing in arbitrage funds.

 

According to Mohit Gang, CEO and MD of Moneyfront, arbitrage funds resemble debt funds in terms of return profiles but are akin to equity funds in taxation, offering safety with better tax efficiency.

 

"In current volatile times, if one has to safely park funds for some time without assuming any risk from market movements, then arbitrage funds, being completely hedged, are great products," Gang stated.

 

Lara added that arbitrage funds are a suitable alternative to debt mutual funds, particularly for individuals in higher tax slabs.

 

For a short-term horizon of three months to one year, arbitrage funds provide relatively stable post-tax returns. The yield-to-maturity (YTM) of arbitrage funds was 6.9 per cent in January 2025. In the past six months, YTM has ranged between 7.1 per cent and 6.8 per cent.

 

Arbitrage funds offer debt-like stable returns with equity-like taxation, making them tax-efficient for individuals in higher tax brackets.

 

What are the tax provisions for arbitrage funds?

 

Arbitrage funds fall under the equity mutual fund category, so they are taxed similarly to equity funds. These funds offer two options: Growth and Dividend, each with different tax rules.

 

Tax on Growth option

 

• If redeemed before one year, it is considered short-term capital gain (STCG), and 20 per cent tax (plus 4 per cent cess) is applicable.
• If redeemed after one year, it is classified as long-term capital gain (LTCG).
• Capital gains up to ₹1.25 lakh per year are tax-free.
• Gains above ₹1.25 lakh are taxed at 12.5 per cent (plus 4 per cent cess).

  Tax on Dividend option

 

• The dividend received from arbitrage funds is added to the investor’s total income.
• The tax is applied based on the investor’s income tax slab.
• Why are arbitrage funds gaining popularity?

 

Arbitrage funds, which offer tax-adjusted returns, have become a popular choice among tax-savvy investors. This rising interest has tripled the category's assets under management (AUM) to ₹2 lakh crore since April 2023.

 

According to the December 2024 Amfi report, the arbitrage fund category now comprises 31 schemes with a total of 5.73 lakh investor folios.

 

This growth has been driven by:

 

• Increase in open interest in stock futures
• Tax benefits associated with arbitrage funds
• Consistent equity sell-off by foreign institutional investors (FIIs), which has widened the gap between the cash and futures markets, creating more arbitrage opportunities 

(Disclaimer: The details of arbitrage funds' performance provided here are for informational purposes only. This is not investment advice. Mutual fund investments are subject to market risks. Please consult your advisor before making any investment decisions.)