1How do arbitrage funds make money?
By capturing the price gap for the same security between the cash and futures markets, with both positions hedged. This keeps returns largely independent of which way the market moves.
Arbitrage funds are a distinctive category that aims for steady, low-risk returns while being taxed as equity. That combination makes them a favourite for parking money over short horizons. Here's how arbitrage funds work, who they suit, and how their taxation sets them apart from other low-risk options.
Reviewed by CA Harika Chebolu, FCA · Last updated 2026-06-15
Quick answer
Arbitrage funds profit from price gaps between cash and futures markets, offering low-risk returns with equity tax treatment. Here's how they work and where they fit.
Arbitrage funds earn returns by exploiting price differences for the same security between the cash market and the futures market. The fund buys in one market and simultaneously sells in the other, locking in the small gap as a near risk-free profit. Because the positions are hedged against each other, the fund's outcome doesn't depend on whether the market rises or falls, which keeps volatility low.
Since each trade is hedged, arbitrage funds aim for steady, modest returns rather than the swings of a typical equity fund. Their returns tend to depend on how many arbitrage opportunities the market is throwing up, which varies with market activity. They're not a guaranteed-return product, but they're built to be far less volatile than directional equity funds.
Arbitrage funds suit investors looking to park money for the short to medium term who want low volatility but prefer equity tax treatment. They're often compared with liquid and short-term debt funds for the same job. The deciding factor is frequently the tax angle, since arbitrage funds are treated as equity while debt funds are taxed differently.
For tax purposes, arbitrage funds are classified as equity funds because of how much they keep invested in equities, even though they're hedged. That means their gains follow equity fund rules rather than debt fund rules, which is the main reason investors choose them over debt options for short-horizon money. The exact treatment depends on your holding period; we'll apply the current rates to your case.
Arbitrage fund returns aren't fixed and can dip when arbitrage opportunities are scarce, so don't treat them as a substitute for an assured-return deposit. Check the fund's expense ratio and any exit load over short periods, since these eat into already-modest returns. Used for the right job — parking surplus with low volatility and equity tax treatment — they can be a useful tool.
By capturing the price gap for the same security between the cash and futures markets, with both positions hedged. This keeps returns largely independent of which way the market moves.
As equity funds, because of how much they keep invested in equities, so their gains follow equity fund rules. The tax angle is the main reason investors prefer them over debt funds for short-horizon money.
Investors parking money short to medium term who want low volatility with equity tax treatment. Returns aren't fixed, so they're not a substitute for an assured-return deposit.
Considering arbitrage funds for surplus cash? Write to the firm and we'll weigh them against your alternatives and apply the current tax rules.