If you are in the 30% tax bracket and want to park money for a year or two, a liquid fund's gains are taxed at your full slab rate. Arbitrage funds earn similar pre-tax returns but are taxed as equity funds, which can leave you with noticeably more after tax. This guide explains how they work, compares five of the largest with data to September 2026, and shows when the tax advantage is real.
What Is an Arbitrage Fund?
An arbitrage fund buys a share in the cash market and, at the same time, sells a futures contract on the same share at a slightly higher price. When the futures contract expires, the two prices meet and the fund keeps the difference. Because it is always both long and short, it takes almost no view on whether the market goes up or down. Returns depend on how wide that price gap is, which tends to track short-term interest rates.
SEBI classifies arbitrage funds as a hybrid category that must hold at least 65% in equity (fully hedged). Since its circular of 26 February 2026, the debt portion may be held only in government securities maturing within a year and government-securities repos.
How They Are Taxed
Because at least 65% is in Indian equity, arbitrage funds count as equity-oriented funds for income tax. For units sold from 1 April 2025:
- Held more than 12 months: 12.5% on gains above ₹1.25 lakh a year.
- Held 12 months or less: 20%.
The ₹1.25 lakh exemption is shared across all your equity gains in a year, not given per fund. Liquid funds, by contrast, hold more than 65% in debt, so gains on units bought since 1 April 2023 are taxed at your slab rate however long you hold them.
The After-Tax Maths
An illustration: ₹5 lakh held for 18 months, assuming a 6.5% a year pre-tax return for both the liquid and the arbitrage fund, and 6.8% for an FD, for an investor paying 30% tax plus 4% cess.
| Option | Tax | Gain after tax | After-tax return (a year) |
|---|---|---|---|
| Liquid fund | 31.2% (slab + cess) | ₹34,079 | about 4.5% |
| FD | 31.2% (slab + cess) | ₹35,678 | about 4.7% |
| Arbitrage fund, gain within your unused ₹1.25 lakh exemption | Nil | ₹49,534 | 6.5% |
| Arbitrage fund, exemption already used elsewhere | 13% (12.5% + cess) | ₹43,094 | about 5.7% |
Illustration only; actual returns vary. Surcharge ignored. Selling an arbitrage fund within 12 months would be taxed at 20% plus cess instead.
So on these assumptions the arbitrage fund leaves you about ₹9,000 to ₹15,500 more than a liquid fund on ₹5 lakh over 18 months. For someone in the 5% or 0% bracket, the advantage mostly disappears.
Five Large Arbitrage Funds Compared
| Fund (current name) | 1 year | 3 years (a year) | 5 years (a year) | Base expense ratio | Total expense ratio (incl. levies) | AUM (₹ Cr) | Exit load |
|---|---|---|---|---|---|---|---|
| Kotak Arbitrage Fund (formerly Equity Arbitrage Fund) | 6.74% | 7.51% | 6.95% | 0.33% | 2.32% | 75,712 | 0.25% within 30 days |
| SBI Arbitrage Fund (formerly Arbitrage Opportunities Fund) | 6.55% | 7.31% | 6.87% | 0.34% | 1.48% | 47,283 | 0.25% within 15 days |
| ICICI Prudential Arbitrage Fund (formerly Equity Arbitrage Fund) | 6.62% | 7.35% | 6.75% | 0.34% | 1.63% | 34,850 | 0.25% within 15 days |
| Tata Arbitrage Fund | 6.77% | 7.51% | 6.86% | 0.26% | 1.61% | 24,950 | 0.25% within 15 days |
| Edelweiss Arbitrage Fund | 6.66% | 7.44% | 6.91% | 0.33% | 1.58% | 14,849 | 0.25% within 15 days |
Direct plan, Growth option, sorted by AUM. Returns calculated from AMFI NAVs to 28 September 2026. AUM as of 31 August 2026. Expense ratios and exit loads as of 22–28 September 2026. HDFC Arbitrage Fund (₹25,509 crore) and Nippon India Arbitrage Fund (₹17,533 crore) are also larger than Edelweiss's, with 5-year returns of 6.69% and 6.81%.
Why the expense ratios look so high
Since 1 April 2026, SEBI's new rules require funds to show a base expense ratio, the fund house's own charges, separately from brokerage and statutory levies such as securities transaction tax (STT), stamp duty and GST. Arbitrage funds trade constantly, so their levies are large. Their base expense ratios are 0.26–0.34%, but their total expense ratios are 1.48–2.32%. Until early 2026 the same funds showed a total of about 0.3–0.45%.
This is a change in how costs are shown, not in what you pay: these costs were always taken out of the NAV. The returns in the table are already after all of them. When comparing arbitrage funds, use the base expense ratio for fund-house charges, and judge the rest by the returns.
What the table tells you
- Returns are very close. One-year returns span 6.55–6.77%, and five-year returns 6.75–6.95%. The strategy is standardised, so no fund stands out for long.
- Size varies a lot. Kotak's fund is more than five times Edelweiss's. All five are well over ₹5,000 crore, which is enough to trade efficiently.
- Exit loads are short. 0.25% if you sell within 15 days (30 days for Kotak).
How Bad Can It Get?
Arbitrage funds rarely lose money, but returns do dip when the cash-futures gap narrows. The worst one-year returns for Kotak's and ICICI Prudential's funds were 3.53% and 3.32%, in the year to May 2021. Each had only 2 negative months out of 152, and the worst month was −0.16% (June 2020).
Other risks are small but real: corporate actions such as unexpected dividends can disturb a hedged position, and rolling positions over in volatile markets can cost more than usual.
What is an income plus arbitrage fund?
An income plus arbitrage fund is a fund of funds that holds debt funds and arbitrage funds together. Under SEBI's master circular for mutual funds (20 March 2026), it can put up to 65% into debt-oriented mutual fund schemes and must put the rest only into arbitrage funds. Since SEBI's February 2026 naming rules, the name ends in "Active FOF" (it buys actively managed funds), "Passive FOF" or "Omni FOF" (a mix of active and passive funds).
Most large fund houses run one. AMFI's expense-ratio data for late September and early October 2026 lists, among others, ICICI Prudential Income plus Arbitrage Omni FOF, Kotak Income Plus Arbitrage Omni FOF, HDFC Income Plus Arbitrage Active FOF, SBI Income Plus Arbitrage Active FOF and Nippon India Income Plus Arbitrage Active Fund of Fund.
How is it taxed compared with an arbitrage fund?
Differently, and the tax is the main reason these funds exist. An arbitrage fund holds at least 65% in Indian equity, so it is taxed as an equity fund, as shown above. An income plus arbitrage fund holds fund units rather than shares, so it does not qualify as an equity-oriented fund. As long as less than 65% of its money is in debt funds, it is not a "specified mutual fund" either, the category whose gains are taxed at your slab rate however long you hold (section 76 of the Income-tax Act, 2025).
That leaves it with the rules for "other" funds. For tax year 2026-27:
- Held more than 24 months: 12.5% on the gain, without indexation and without the ₹1.25 lakh exemption.
- Held 24 months or less: your slab rate.
For a 20% or 30% bracket investor, a pure arbitrage fund is usually the lower-tax choice for money held under two years, because it reaches the 12.5% rate after one year instead of two. Over longer holds, an income plus arbitrage fund lets the debt-fund part of your return be taxed at 12.5% instead of your slab rate. The 65% test uses the yearly average of daily holdings, so check the fund's scheme information document for its debt-fund range before you rely on this treatment.
When Arbitrage Funds Make Sense
- Parking money for 12–24 months if you are in a 20% or 30% bracket, especially if you have not used your ₹1.25 lakh equity exemption.
- Holding a lump sum while moving it into equity funds gradually through a systematic transfer plan (STP).
- The slower part of an emergency fund, alongside a liquid fund for money you may need at once.
When They Don't
- Very short holds: within 12 months gains are taxed at 20%, and exit loads apply in the first 15–30 days.
- Low tax brackets: the after-tax advantage over a liquid fund largely disappears.
- Money you may need immediately: liquid funds offer instant redemption of up to ₹50,000 or 90% of your investment a day, whichever is lower. That facility is for liquid funds; check an arbitrage fund's payout time in its scheme information document.
- Long-term wealth building: a 6–7% return will not match equity over 10 years or more.
For more on where to keep short-term money, see liquid fund vs savings account vs FD and our emergency fund calculator.
How to Compare Arbitrage Funds
- Choose the Direct plan.
- Compare base expense ratios, not total expense ratios, for fund-house charges.
- Check returns over 3–5 years and look for steady monthly returns.
- Prefer a large fund (several thousand crore or more) with a long track record.
- Check the exit load period against how long you plan to hold.
This guide explains how to compare these funds. It is not a recommendation to buy any specific fund.
Related fund guides
Run your numbers: to see what a one-time amount parked in an arbitrage fund could grow to over your holding period, use the lumpsum calculator. If you'll draw the money down in monthly instalments instead, the SWP calculator shows how long it lasts.