Best Arbitrage Mutual Funds for Short-Term Investment in 2025

The Indian mutual fund industry has witnessed significant expansion, with arbitrage funds becoming a preferred choice for short-term investments. As of 2024, these funds have continued to perform well despite fluctuating market conditions. The consistent inflows into arbitrage funds indicate growing investor trust in their ability to provide tax-efficient returns and capital protection.

What Are Arbitrage Mutual Funds?

Arbitrage funds are a category of mutual funds that aim to generate low-risk returns by capitalising on the price differences between two or more markets, typically the cash market and the derivatives market.

Fund managers employ a hedging strategy by simultaneously buying a security in the cash market and selling it in the futures market at a higher price. This strategy ensures low-risk returns while maintaining liquidity. These funds are particularly attractive because they offer a combination of equity taxation benefits and a relatively low-risk profile.

[Read: 3 Best Liquid Funds for 2025 – Top Liquid Mutual Funds for 2025]

Unlike traditional equity funds, where returns are linked to market movements, arbitrage funds’ performance depends on the availability of arbitrage opportunities. This makes them appealing to conservative investors, especially during periods of market volatility when such opportunities tend to be more abundant.

Key Features of Arbitrage Funds:

1. Low Risk, Hedged Strategy

Arbitrage funds follow a hedged strategy where security is bought in one market (cash market) and simultaneously sold in another (futures market). This dual position ensures that the investment is relatively insulated from the price fluctuations in the market, minimising risk. Unlike equity funds, returns are not dependent on market direction but on the availability of arbitrage opportunities.

2. Tax Efficiency

For taxation purposes, arbitrage funds are treated as equity funds. This classification provides significant tax advantages:

For equity mutual funds, gains from units held up to 1 year (12 months) before redemption are considered Short Term Capital Gains (STCG) and taxed at a rate of 20%. If held for over 1 year, they attract Long Term Capital Gains (LTCG) tax at 12.5% on gains exceeding Rs 1.25 lakh annually. These tax benefits make arbitrage funds more appealing than many debt-oriented schemes.

3. Steady Returns in Volatile Markets

Arbitrage opportunities increase during market volatility, allowing these funds to lock in higher returns. While the returns are typically modest compared to equity funds, they are more consistent, especially during turbulent times.

4. High Liquidity

Arbitrage funds maintain a significant portion of their portfolio in cash or cash equivalents, ensuring ample liquidity. This feature makes them suitable for investors looking for short-term investment avenues or emergency fund placement.

5. Portfolio Composition

Typically, 65% to 85% of the fund is allocated to liquid, large-cap stocks in the cash market, which present opportunities for arbitrage. The remaining 15% to 35% is allocated to futures contracts on the same stocks, allowing the fund to profit from price differences between the cash and futures markets.

Additionally, a small portion, usually 0% to 10%, is held in cash or cash equivalents like money market instruments or short-term debt, ensuring liquidity and flexibility. This hedged strategy aims to generate moderate returns with lower risk, relying on efficient execution and frequent arbitrage opportunities.

Why One May Consider Arbitrage Mutual Funds?

Arbitrage mutual funds offer a unique proposition for investors seeking a balance between stability and tax efficiency. Unlike other mutual funds, their strategy of leveraging price discrepancies between the cash and futures markets ensures returns are less influenced by broader market trends. This makes them particularly appealing for investors looking to earn modest yet consistent returns during times of market uncertainty or economic turbulence.Bottom of Form

[Read: Should You Consider Arbitrage Funds After Change in Debt Mutual Fund Taxation]

Additionally, these funds cater to short-term goals, serving as an effective alternative to fixed deposits or other low-risk instruments, thanks to their equity-oriented tax benefits. Arbitrage funds are also a valuable option for parking surplus cash temporarily, ensuring liquidity without compromising on potential gains. Their hedged nature and focus on minimising risks make them a versatile choice in an investment portfolio, particularly for those prioritising financial stability over aggressive growth.

• Best Arbitrage Mutual Funds #1 – Kotak Equity Arbitrage Fund

  
  

  Kotak Equity Arbitrage Fund, launched on September 29, 2005, is an open-ended scheme that capitalises on arbitrage opportunities within the equity market. The scheme aims to generate capital appreciation and income by predominantly investing in arbitrage opportunities in the cash and derivatives segment of the equity market, as well as by investing the balance in debt and money market instruments.

  
  

  The fund’s strategy involves taking long positions in the cash market and corresponding short positions in the futures market to exploit price differentials, aiming to provide investors with income through these arbitrage opportunities. Over the year, the fund has built an AUM of Rs 54,915.38 crores and has found a place among top-performing arbitrage schemes, boasting superior returns across time frames.

  
  
  

  Graph 1: NAV Growth of Kotak Equity Arbitrage Fund in the Last Three Years

  
  

  
  
  
  
  The securities quoted are for illustration only and are not recommendatory.
  
  Past performance is not an indicator of future returns
  
  Base = Rs 10,000/-
  
  Data as of December 31, 2024
  
  (Source: ACE MF, data collated by PersonalFN)
  

  Over the last one-year period, Kotak Equity Arbitrage Fund has recorded an absolute growth at 8.53% on a rolling return basis, higher than the growth of 7.90% in the benchmark Nifty 50 Arbitrage index. In terms of performance, the fund has demonstrated consistent returns. This highlights the fund’s ability to generate superior returns across time horizons while maintaining stability, making it a competitive choice for investors seeking low-risk arbitrage opportunities in volatile markets.

  
  
  

  Top Portfolio Holdings in Kotak Equity Arbitrage Fund

  
  

  
  
  
  
  The securities quoted are for illustration only and are not recommendatory.
  
  Past performance is not an indicator of future returns
  
  Data as of December 31, 2024
  
  (Source: ACE MF, data collated by PersonalFN)
  

  The Kotak Equity Arbitrage Fund demonstrates a well-diversified portfolio, with its top holdings spread across leading companies in India. Reliance Industries Ltd. has the highest allocation at 5.80%, reflecting its significant role in the Indian economy. This strategic allocation provides stability and consistent returns, leveraging the performance of market leaders in their respective sectors.

  
  

  Sector-wise, the fund showcases a balanced approach, with Banks leading at 23%, followed by Automobile & Ancillaries, Crude Oil, and Finance, each holding 13%. The presence of defensive sectors such as FMCG (6%) and Healthcare (6%) further strengthens the portfolio, making it resilient against market fluctuations. This thoughtful allocation underscores the fund’s aim to achieve steady growth while safeguarding against volatility.

  
  

  The fund is managed by Mr Hiten Shah, who has been at the helm since October 3, 2019. Investors should note that past performance may not be indicative of future results, and one must consult financial advisors to determine the suitability of this investment for their individual financial goals.

• Best Arbitrage Mutual Funds #2 – Edelweiss Arbitrage Fund

  
  

  Edelweiss Arbitrage Fund is an open-ended mutual fund scheme launched by Edelweiss Asset Management Limited, a subsidiary of the Edelweiss Group. The fund was launched on June 27, 2014. As an arbitrage fund, it primarily invests in equity and equity-related instruments, taking advantage of arbitrage opportunities while also allocating a portion of its assets to debt and money market instruments to manage liquidity.

  
  

  The fund’s investment strategy focuses on exploiting arbitrage opportunities by simultaneously buying securities in the cash market and selling them in the futures market. The scheme currently holds an AUM of Rs 12,199.21 crores and draws allocation across market caps – 58.78% in large cap stocks, 13.34% to mid-caps and 2.85% in small-cap stocks.

  
  
  

  Graph 2: NAV Growth of Edelweiss Arbitrage Fund in the Last Three Years

  
  

  
  
  
  
  The securities quoted are for illustration only and are not recommendatory.
  
  Past performance is not an indicator of future returns
  
  Base = Rs 10,000/-
  
  Data as of December 31, 2024
  
  (Source: ACE MF, data collated by PersonalFN)
  

  The scheme has delivered a consistent performance across various time frames. Over the past one year, the Edelweiss Arbitrage Fund has delivered an absolute return of approximately 8.42%, outperforming the category average and benchmark returns at 7.67% & 7.90%, respectively and aligning with the typical performance of arbitrage funds in the Indian market. With a disciplined investment approach and a focus on risk management, it aims to provide investors with stable returns while maintaining liquidity.

  
  
  

  Top Portfolio Holdings in Edelweiss Arbitrage Fund

  
  

  
  
  
  
  The securities quoted are for illustration only and are not recommendatory.
  
  Past performance is not an indicator of future returns
  
  Data as of December 31, 2024
  
  (Source: ACE MF, data collated by PersonalFN)
  

  Among the top holdings, Reliance Industries Ltd. has the largest allocation at 5.06%, followed by ICICI Securities Ltd. at 4.17%, and Vedanta Ltd. at 2.94%. Other prominent holdings include Bharti Airtel Ltd. (2.24%), ICICI Bank Ltd. (2.16%), and HDFC Bank Ltd. (1.52%). This composition indicates a focus on high-performing companies across key industries.

  
  

  In terms of sector allocation, the portfolio demonstrates a significant tilt towards Banking (23%) and Finance (18%), highlighting the importance of the financial sector in its investment strategy. Other sectors, such as Healthcare (7%), Non-Ferrous Metals (7%), FMCG (5%), Telecom (5%), and Capital Goods (5%), provide additional diversification, ensuring a balanced approach to growth and risk mitigation across multiple economic drivers.

  
  

  Edelweiss Arbitrage Fund offers a conservative investment avenue by leveraging arbitrage opportunities in the equity markets. Its tax-efficient structure, due to equity taxation, makes it an attractive alternative to traditional debt funds, especially for those in higher tax brackets.

• Best Arbitrage Mutual Funds #3 – Invesco India Arbitrage Fund

  
  

  Launched in April 2007, Invesco India Arbitrage Fund is a well-known offering in the arbitrage category. The fund aims to cater to investors seeking short-term parking for surplus funds or those seeking a safer option during volatile market conditions. It positions itself as a tax-efficient alternative to traditional debt funds due to its equity-oriented taxation benefits.

  
  

  Over the years, the fund has steadily gained popularity, leading to significant growth in its AUM, which currently stands at Rs 18,251.89 crores. The increasing AUM reflects investor confidence, particularly during times of heightened market volatility when arbitrage opportunities are more abundant. The fund’s focus on maintaining liquidity and stable returns has contributed to its consistent growth trajectory.

  
  
  

  Graph 3: NAV Growth of Invesco India Arbitrage Fund in the Last Three Years

  
  

  
  
  
  
  The securities quoted are for illustration only and are not recommendatory.
  
  Past performance is not an indicator of future returns
  
  Base = Rs 10,000/-
  
  Data as of December 31, 2024
  
  (Source: ACE MF, data collated by PersonalFN)
  

  The Invesco India Arbitrage Fund has historically delivered returns in line with other funds in the arbitrage category. Over the past one year, the scheme has delivered absolute gains of around 8.42%, being at par with it’s peers and outperforming the category average & benchmark.

  
  

  While returns are typically modest, they align well with the low-risk nature of the fund. The performance of such funds largely depends on the availability of arbitrage opportunities in the market and the efficiency of fund management. A smaller portion of the portfolio is invested in debt and money market instruments, ensuring liquidity and meeting redemption requirements.

  
  
  

  Top Portfolio Holdings in Invesco India Arbitrage Fund

  
  

  
  
  
  
  The securities quoted are for illustration only and are not recommendatory.
  
  Past performance is not an indicator of future returns
  
  Data as of December 31, 2024
  
  (Source: ACE MF, data collated by PersonalFN)
  

  Reliance Industries Ltd. holds the top position with an allocation of 8.03%, followed by Tata Motors Ltd. at 4.14% and Indusind Bank Ltd. at 2.90%. The remaining companies in the top 10 have allocations ranging from 1.35% to 1.94%. These allocations, while smaller in size, likely represent investments in companies with strong growth prospects, specific industry expertise, or strategic importance to the overall portfolio diversification.

  
  

  The banking sector commands the largest allocation at 23%, indicating a significant exposure to the Indian banking industry. The portfolio demonstrates a significant tilt towards the Oil industry (17%) and Finance (16%). The remaining sectors, including Automobile & Ancillaries, Capital Goods, IT, FMCG, etc., have smaller allocations ranging from 4% to 12%. These allocations likely contribute to diversification across various sectors and may reflect specific investment themes or opportunities identified within these sectors.

  
  

  With the potential for stable returns and tax benefits, it is likely to remain a preferred option for conservative investors in 2025 and beyond. However, investors should remain mindful of expenses and market liquidity, which can influence net returns.

To conclude…

As we step into 2025, the market outlook for arbitrage funds remains positive, but certain factors will be crucial in shaping their performance. The sustained growth of the Indian derivatives market, increased participation by institutional investors, and regulatory support will continue to provide ample arbitrage opportunities. However, returns may fluctuate in line with interest rate movements and market volatility, necessitating a cautious approach.

For investors, arbitrage funds can serve as a cornerstone for portfolio diversification, balancing risk with stable returns. While their tax advantages and liquidity make them appealing, it is essential to align these funds with your investment horizon and financial goals. With the evolving market dynamics, staying informed and consulting with a financial advisor can help optimise your investment strategy.

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MITALI DHOKE is a Research Analyst at PersonalFN. She is an MBA (Finance) and a post-graduate in commerce (M. Com). She focuses primarily on covering articles around mutual funds including NFOs, financial planning and fixed-income products. Mitali holds an overall experience of 4 years in the financial services industry.

She also actively contributes towards content creation for PersonalFN’s social media platforms in the endeavour to educate investors and enhance their financial knowledge.

 

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.