Arbitrage Funds Losing Edge? Here’s What Changed

Added: 2026-04-30

[00:00:07]Hi, we're talking about your money matters on NDTV Profit and my name is Alex Mathew.

[00:00:12]What do you do for your short-term requirements? When you have to park money and you don't want to leave it lying in your savings bank account. You've probably seen a lot of stories that tell you that's the worst thing to do.

[00:00:25]But you need to have it accessible as well, right? So, a lot of people have talked about arbitrage funds, they've talked about liquid funds, they've talked about things like income plus arbitrage funds. But there was a change in the way that derivatives are treated in terms of the cost that is paid. And so, does that change the math for you and how much arbitrage funds will yield? Let's ask Vishal Dhawan, who is the founder and chief executive officer of Plan Ahead Wealth Advisors. Vishal, thanks so much for taking the uh the time.

[00:00:56]So, let me first ask you to describe how each of these products works and why we're talking about arbitrage funds having a lower return expectation than before.

[00:01:09]Thanks, Alex. It's a pleasure to be here as always. So, um so I think there are two things that are important to keep in mind. One is the budget that got presented um you know, a couple of months ago, did increase the cost of the way STT would get charged on uh futures and options. As a result of which arbitrage funds which tend to use a lot of F&O uh derivative transactions automatically saw a possible increase in expenses uh because of the frequent trading that they end up doing in that segment.

[00:01:43]Uh the expectation is that that would probably end up impacting the cost by somewhere between 0.2 to 0.35% per annum.

[00:01:54]So, clearly, uh you know, that's one sort of impact that is coming through. I think there's a very important other thing that happened which started a little earlier that uh arbitrage returns tend to be very linked to interest rates in the economy.

[00:02:09]And therefore, if you go back in history and look at the returns that you made on arbitrage funds 2 years ago versus the returns that you made in the last 1 year or so, you'll find that there has been about a 1% shift in arbitrage returns downwards.

[00:02:26]And while a lot of people may end up attributing it only to this cost uh change, the bigger reason is the fact that interest rates have come down.

[00:02:35]And because interest rates have come down and and arbitrage funds tend to uh you know, park a part of the money in debt kind of instruments depending on what are the alternatives available, there's been a natural progression downwards in terms of expenses. So, these two have combined together to actually reduce arbitrage costs.

[00:02:57]Uh sorry, arbitrage returns. So, the costs are a smaller segment as compared to the overall return impact. Okay, okay. So, that's interesting. So, that's the latest. But uh for those people that are unaware of how this works, let's run through how each of these works. And there are three products that we're primarily speaking about today. One is your liquid funds and your ultra short-term debt funds. Uh then there is the arbitrage funds which a lot of people have had started preferring because of the equity tax taxation. And then there's the income plus arbitrage funds which have that fund of fund uh treatment uh by my understanding.

[00:03:36]Vishal, please correct me if I'm wrong.

[00:03:37]And so, therefore, the tax treatment is not as adverse as your fixed income funds.

[00:03:44]That's correct. So, I think um you know, there are two aspects to it. One is what is the kind of holding period you should have on this money that you have kept aside for shorter-term needs to get the tax benefit. And the second is what is the product design itself aligned to. So, if you look at liquid funds, for example, they're typically designed for money which is being kept for a few weeks uh most often because most liquid funds will have an exit load up to 7 days. So, if you have money for example, for just a day or two, you may not find the liquid fund very efficient because it has an exit load.

[00:04:22]What a liquid fund does is it goes and invests in very short-term and money market sort of instruments.

[00:04:28]And the returns fairly largely come from the interest income that these instruments actually generate. And therefore, they're a good place to park emergency funds where you don't know exactly when I will require the money, but I expect and anticipate that it'll be a few weeks to a few months.

[00:04:44]In contrast, if you look at the arbitrage funds, what they're actually trying to do is uh find equity arbitrage opportunities, which means that if there is a particular stock in the cash market and another stock uh in the futures market where there is an arbitrage available between the two, uh the fund manager will try to lock in this arbitrage by buying in cash and selling in futures simultaneously. So, the intent is to try to not take the risk of directional movement of the markets, but simply lock into the gain at that moment. Now, when that happens, the uh typically um the typical sort of impact is that the volatility tends to be much lower because if you're a fund manager and you don't find these opportunities, you may end up then parking it temporarily uh in debt instruments itself.

[00:05:35]Now, because of the tax treatment in these instruments which become long-term after a 12-month period and then get taxed at equity levels, which is 12 and 1/2%, you will typically find that these instruments are ideally suited for 1 year plus if you're doing it purely for the tax reason. But even if you hold it short-term and you know, these are not instruments which are designed in our view for 1 month holding periods, but you need to have at least a 3 to 6 month holding period before you go to an arbitrage fund. If you went there, you would still get a short-term tax. And the short-term tax for someone who's in a high tax bracket is only 20%.

[00:06:13]Whereas if he kept parked it in a liquid fund, it would actually end up being at the marginal tax rate which could go up to 30, 33, 35%.

[00:06:22]Uh the income plus arbitrage product basically tries to combine debt plus arbitrage opportunities together.

[00:06:30]Uh it's a very interesting uh proposition for a lot of investors in the higher tax bracket because like you rightly mentioned, Alex, because of the way it's structured as a fund of funds, it gets the benefit of a long-term capital gain treatment. The only difference is that the holding period needs to be at least 2 years to get that 12 and 1/2% long-term capital gain. So, very clearly, depending on what time frame you're going to hold each money for and which tax bracket you are under, the choice between liquid, arbitrage, or income plus arbitrage may vary.

[00:07:03]Yeah, yeah. So, first and foremost, what do you need the money for is the question you need to be asking. And Vishal, most people don't ask that question before they invest in anything, which is why we're doing this program.

[00:07:16]But having said that, beyond these three, there's also hybrid SIFs, uh which is uh something that has been launched in the recent past.

[00:07:28]Um can you describe how they work and how they're different from what you've described already so far?

[00:07:35]Yeah, so um I think the important thing to remember is that the uh specialized investment funds or SIFs are not really simple cash parking instruments. Uh they're basically designed as income generating strategies where essentially you use a combination of arbitrage and fixed income on one side and then you also try to see if there are some selective opportunities available in derivatives or or in the form of um you know, uh special situations which might create some additional opportunities to make returns.

[00:08:12]So, the idea here is, you know, how do you get a return which is higher than our traditional arbitrage fund, but keep the volatility low as compared to the traditional hybrid fund which, you know, normally had exposures in equities which were anywhere between uh 30 to 40% going all the way up to 70 to 80%. So, they are very different because of the way they are structured.

[00:08:35]Um like you rightly pointed out, you know, these are products which are relatively newly launched. Because they're relatively newly launched, you don't have a lot of live track records to go by. Though most of them would have some sort of backtesting data which would be available.

[00:08:52]Uh but you need to keep in mind that, you know, a lot of what you see on arbitrage funds or income plus arbitrage or on liquid funds has already got demonstrated in a live environment.

[00:09:03]Whereas a lot of what you see in hybrid SIFs is essentially backtested data and some data because the oldest hybrid SIF is now roughly about 6, 7 months old.

[00:09:13]The advantage of the hybrid SIF is that it also gets equity tax treatment. Uh if you hold for more than 12 months, it will be taxed at 12 and 1/2%. And it also allows you to come in with very limited sort of minimums because the minimum investment in a hybrid SIF or any SIF is 10 lakh rupees, uh which is higher than what you would give in a mutual fund like an arbitrage fund or an income plus arbitrage or a liquid fund, but lower than traditionally where people went to these kind of arbitrage instruments which were essentially alternative investments funds or what are called AIFs.

[00:09:50]And uh what it's done is it's created a category in between where these sort of instruments come in. So, I think the way to think about this is it's an in-between product between a more large value uh high net worth oriented AIF and a traditional mutual fund that you would normally use. But, it's clearly not a direct replacement for an arbitrage fund uh for example because it's trying to do something different because it's using derivatives, equity, debt, all of this together in one single structure to be able to try to get you an more appropriate risk-adjusted return. Okay. So, uh let's put this in that framework of time that you should be willing to hold for.

[00:10:36]If you talk about liquid funds at the absolute base, uh describe the entire landscape for us, Vishal.

[00:10:43]Yeah. So, we would say typically liquid funds uh for a few weeks to a to a few months.

[00:10:50]Look at arbitrage if you have at least a 3 to 6-month investment horizon and longer.

[00:10:56]Uh look at the income plus arbitrage category if you have a 2-year plus investment horizon. And look at the hybrid SIF category if you have a in our view 2 and 1/2 to 3-year investment horizon simply because there is no track record there and therefore even if there are some months in which things don't go well for the fund managers, there is enough time for a recovery to happen for you to be able to get the optimized sort of rate of return adjusted for risk on this portfolio. Okay, so that's well put. The other thing to bear in mind of course is that if you are only investing in one specialized investment fund, in this case a hybrid fund, your minimum holding has to be that 10 lakh amount. You can't unlike in mutual funds, you can't pull out a small amount of money. You have to maintain a 10 lakh limit, right?

[00:11:49]That's correct. So, it it is targeting a very different uh segment because the product is more complex. So, I think we need to understand that the architecture around SIFs has partly been designed around the fact that it is assuming that the investor coming in there is more aware, has a higher tolerance for downside risk because there is uh derivatives being used and there are guardrails which are being put on the side to ensure that the investor is not taking uh unbridled risk or the fund manager is not taking too much risk in this entire process.

[00:12:24]Uh one of the very other sort of important things if I may add to this is also that because there aren't so many track records, you may end up having more than one hybrid SIF in your portfolio unlike you know, arbitrage or liquid or um income plus arbitrage because there you have track records to go by. You might decide that I'm okay with concentrating my money.

[00:12:45]Whereas in a hybrid SIF because there's no track record, you may deliberately end up putting it across multiple schemes and that essentially means 10 lakhs plus 10 lakhs if you want to do two schemes for example.

[00:12:57]>> Yeah. Yeah, that's an important point.

[00:12:59]All right, so uh relevance exists for what we've discussed in the first half. SIFs is more conditional and of course you need to have a certain amount of scale of investment if you want to participate in that. Vishal, thanks so much for taking the time.

[00:13:15]Pleasure speaking with you.

[00:13:17]Always a pleasure. Thank you.

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