STT hike on F&O trades to eat into arbitrage fund returns: Experts

Schemes may see 30-50 bps impact but won't go out of favour

The hike in securities transaction tax (STT) on futures and options (F&O) trades is set to pinch arbitrage funds — the short-term investment option preferred by investors to park extra cash.

 

Experts see a 30-50 basis points (bps) decline in returns once the higher STT kicks in the next financial year.

 

Arbitrage funds transact heavily in the F&O segment with an aim to generate returns by exploiting price differences between the cash and derivatives markets.

 

The category has become sizeable in recent years, especially after the change in debt fund taxation in 2023.

 

Between January 2023 and December 2025, the assets managed by arbitrage funds have grown nearly fourfold to ₹2.8 trillion.

 

“The biggest players in futures are arbitrage funds. Its returns will fall by about 0.5 per cent next year due to this increased STT,” said Deepak Shenoy, chief executive officer (CEO), Capitalmind Asset Management.

 

According to an analysis by Edelweiss MF, the rise in STT could shave off 0.32 percentage point return of arbitrage funds on an annualised basis considering average arbitrage strategy exposure at 70 per cent.

 

However, the arbitrage funds may still manage to beat liquid funds, given the large variance in taxation, the analysis showed.

 

Returns from arbitrage funds are taxed at 12.5 per cent (if invested for more than a year), as they qualify for equity taxation. In the case of liquid funds or any other debt fund, it can be over 30 per cent as the returns are taxed at the investors' slab rate.

 

According to Vivek Rajaraman, managing director (MD), head - client advisory, Waterfield Advisors, while the lower returns will reduce the attractiveness of arbitrage funds, they may remain the preferred option for short-term investments.

 

“The net tax advantage it enjoys vis-à-vis other short-term parking options such as liquid, ultra short or even low duration continues to make it look better on a post-tax basis. Hence, we don’t expect a shift to happen immediately. But we might see other asset classes also being in the consideration set,” he said.

 

The higher STT on F&O will also hurt other hybrid schemes which use arbitrage strategies. Equity savings funds and select multi-asset allocation funds use F&O to some extent.

 

Most schemes in the newly-introduced segment within MFs — specialised investment funds (SIFs) — will also see some impact, experts said.