Why are arbitrage funds so popular among hybrid mutual fund investors?

Arbitrage funds have gained significant popularity among hybrid mutual fund schemes in India, especially among conservative investors seeking a balance between risk and return.

But why are arbitrage funds so popular?

Pankaj Mathpal, MD & CEO at Optima Money Managers, says these funds exploit market inefficiencies by taking advantage of short-lived price differences in identical or similar instruments across markets.

"Arbitrage funds earn profits by buying at a lower price in one market and simultaneously selling at a higher price in another," he said.

Arbitrage mutual funds have witnessed strong and consistent net inflows over the past few months, reflecting growing investor preference for low-risk and tax-efficient investment options.

According to AMFI (Association of Mutual Funds in India) data, the category saw net inflows of ₹11,790.37 crore in April 2025, which rose to ₹15,701.97 crore in May and ₹15,584.57 crore in June.

While there was a decline in July, with net inflows at ₹7,295.70 crore, the overall trend remains positive. These inflows suggest that investors continue to view arbitrage funds as a reliable option for parking short-term surplus funds, especially amid market uncertainty.

• July 2025: ₹7,295.70 crore
• June 2025: ₹15,584.57 crore
• May 2025: ₹15,701.97 crore
• April 2025: ₹11,790.37

In fact, the average net AUM (Assets Under Management) of all arbitrage funds in July 2025 crossed ₹3,00,840 crore, making it larger than some popular equity fund categories like multi-cap and ELSS. Notably, it is also almost equal to the combined AUM of all index funds, which stood at approximately ₹3,08,319 crore.

As per the latest data available on the AMFI website, several arbitrage funds have delivered consistent one-year returns.

The Kotak Arbitrage Fund leads in terms of Daily Average AUM at ₹71,470 crore, delivering a one-year return of 7.52%. Following this is the SBI Arbitrage Opportunities Fund with an AUM of ₹40,500.6 crore and a return of 7.46%.

The ICICI Prudential Equity Arbitrage Fund also holds a significant AUM of ₹31,468.37 crore, yielding a return of 7.48% over the past year. Invesco India Arbitrage Fund and Aditya Birla Sun Life Arbitrage Fund reported returns of 7.53% and 7.59%, respectively, with AUMs of ₹23,946.83 crore and ₹22,799.37 crore.

The Tata Arbitrage Fund, despite a smaller AUM of ₹17,492.16 crore, delivered the highest return among the listed funds at 7.65%. Edelweiss Arbitrage Fund and Nippon India Arbitrage Fund had AUMs of ₹15,685.41 crore and ₹15,384.61 crore, offering one-year returns of 7.51% and 7.3%, respectively.

For investors, it's essential that returns on investments at least keep pace with inflation. In India, the average inflation rate is 6%. Arbitrage funds, with recent one-year returns ranging between 7.3% and 7.6%, are currently offering returns that outpace inflation.

"In debt funds, the total capital gains irrespective of the holding period are added to the investor’s income and taxed at applicable slab rates, capital gains on arbitrage funds are taxed like equity," explained Mathpal. Hence, they offer low risk, tax efficiency, and better post-tax returns than debt funds.

Hybrid funds are classified as equity-oriented for taxation purposes.

• Short-term capital gains (STCG) are taxed at 20% (if held for less than 12 months)

• Long-term capital gains (LTCG) are tax-free up to ₹1.25 lakh per annum and taxed at 12.5% beyond that.

According to investment and tax expert Balwant Jain, one should invest part of their emergency fund in Arbitrage funds as you will have to pay exit load.

"If you're looking for a low-risk place to park your money temporarily, arbitrage funds can be a very smart choice. For investors with smaller incomes or short-term needs, liquid funds may be more suitable," said Jain.

Meanwhile, despite heightened market volatility plagued by tariff war with the US, equity-oriented mutual funds garnered a net inflow of ₹42,702 crore in July, making it the highest-ever monthly tally for the segment, as per the data released by AMFI on August 11, 2025.