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# Blog Posts
## Stop Calling It “Arbitrage”: The Great Carry‑Trade Rebrand
Published: 2025-06-12
Category: Insights by Raghav Malik
Category URL: https://investhq.in/blog/category/insights-by-raghav-malik/
Tags: Arbitrage Funds
Tag URLs: Arbitrage Funds (https://investhq.in/blog/tag/arbitrage-funds/)
URL: https://investhq.in/blog/stop-calling-it-arbitrage/

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/add-a-subheading-2400-x-1600-px-2-1749750925143-compressed.png)

## 1\. Why This Post Exists

I’ve executed **real‑world arbitrage** \- buying Reliance on the BSE and selling it on the NSE in the same breath (first by slamming my keyboard, later via co‑lo algos); squeezing pennies out of put‑call‑parity gaps; even locking bull‑call spreads, bear‑put spreads, and long butterflies **for a credit.** Those trades left zero market risk once hedged and vanished the moment another desk hit them.

So when I see Indian mutual funds pitch their cash‑and‑carry product as “arbitrage,” my spidey‑sense tingles. **_It’s carry. It’s debt with an equity tax wrapper. Useful, yes. Arbitrage, no._** This post breaks down what these funds really do and where the landmines hide.

I have already done a deep dive on Arbitrage Funds [here](https://investhq.in/blog/arbitrage-funds-deep-dive/).

* * *

## ​2\. What _Actual_ Arbitrage Looks Like

Test

True Arbitrage (what I ran)

Cash‑Futures “Arb” Fund

**Trade example**

Buy Reliance on BSE, sell on NSE ‑‑ OR lock in some form of put-call-parity violation

Buy Reliance cash, short Reliance 1‑M fut

**Source of P&L**

Law‑of‑one‑price violation (structural mis‑pricing/dislocations possibly sparked by fat orders)

Cost‑of‑carry (interest‑dividend)

**Convergence speed**

Seconds in 2009 … micros now … **nanoseconds** on FPGA

30‑45 days (expiry)

**Capital at risk**

After hedge ≈ zero (just slippage)

Margin + inventory + funding cost

**Residual risks**

Operational stupidities/errors like KCG

Credit, liquidity, redemption shock

If your P&L trickles in **over a month**, you’re harvesting **carry**, not arbitrage.

* * *

## 3\. What These Funds Actually Hold

1. **​65‑70 % Cash‑Futures Carry**
   1. Long cash, short fut, harvest the basis.
2. **30‑35 % Short‑Duration Debt**
   1. Repos, CPs, bank CDs, NCDs - juice the yield, pledge for margin, add credit tail‑risk.

In 2018 DHFL paper was stamped **AAA** right up until it detonated and carved ~5 % out of some “arbitrage” NAVs. Rating doesn’t immunise you.

* * *

## **4\. The Marketing Alchemy**

- **Tax optics** \- Clear 65 % equity exposure, claim equity LTCG @ 12.5 %.
- **Sales psychology** \- _“Arbitrage”_ sounds brainy and “risk‑free.” _“Carry trade with bond sleeve”_ on a pdf brochure just doesn’t hit the same chord. At least stat‑arb and risk‑arb desks tag their trades honestly (yes, I’ve done both); their comp rides on P&L, not just AUM (2 and 20 anyone?).
- **Legacy inertia** \- Name stuck in 2006? I dunno, GPT gave me this point.

* * *

## **5\. Desk vs Fund - Apples and Rocketships**

My Inter‑Exchange Stock Arb

Cash‑Futures Carry Fund

**Hold period**

nano‑seconds → minutes → days (if you can warehouse your locked arb)

30‑45 days

**Tech stack**

Colo + FPGA + cross‑connect

Excel + OMS

**Tail risk**

KCG! READ ABOUT IT!

Bond default, mass redemption

Same word, different galaxy.

* * *

## **6\. Investor Checklist (Read This, Then Decide)**

1. **See through the label.** You’re buying carry + credit, not instantaneous arb.
2. **Probe the debt sleeve**. Ask for exact weight in sub‑AAA, but remember: even “AAA” can default (DHFL says namaste).
3. **Watch spread compression.** RBI cuts → basis shrinks → yield drops.
4. **Size appropriately**. I park ~10 % of my MF pile here - my cash bucket - accepting a potential 3‑5 % drawdown.
5. **Party small‑talk guidance.** If you call it risk‑free arbitrage, quants will mock you behind your back and you’ll mislead the novices. (To be fair, at most parties the only question I get is “NIFTY teji mein hai ya mandi mein?” - same energy as me cornering a doctor to review my blood-test PDF.)

* * *

## **7\. Rename Proposal**

- **Carry & Credit Fund (Equity‑Oriented)** – dull but honest.

- **Basis‑Capture & Short‑Debt Fund** – never getting past marketing.


Until SEBI re‑badges them, the misnomer stays. Just **know** what’s under the hood.

* * *

## **8\. Final Word**

Cash‑and‑carry funds are handy, [tax‑efficient](https://investhq.in/blog/arbitrage-funds-low-risk-tax-efficient/), low‑vol parking lots.

But they’re a **carry trade tied to a bond sleeve**, not the arbitrage I grew up on.


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## Arbitrage Funds: Low Risk, Tax Efficient…Too Good to Be True?
Published: 2025-06-05
Category: Insights by Raghav Malik
Category URL: https://investhq.in/blog/category/insights-by-raghav-malik/
Tags: Arbitrage Funds
Tag URLs: Arbitrage Funds (https://investhq.in/blog/tag/arbitrage-funds/)
URL: https://investhq.in/blog/arbitrage-funds-low-risk-tax-efficient/

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/add-a-subheading-2400-x-1600-px-3-1749125800940-compressed.jpg)

We’ve already covered arbitrage funds in [this blog](https://investhq.in/blog/arbitrage-funds-in-india/) and [this one](https://investhq.in/blog/arbitrage-funds-deep-dive/). Both these articles show arbitrage funds in a fairly positive light. That wasn’t the intent, but for once, what is advertised does seem to hold true.

I was more curious about how these funds work, and if there’s any hidden risks when holding these kinds of funds. So I dug deeper. Typically, the kind of cash-future carry arbitrage strategies these funds deploy are negative skew in nature. So my first bit of investigation was in that direction.

## Negative skew

Short primer

When an asset has a higher chance of a large down move than a large up move, then the asset’s returns are negatively skewed. Imagine making 0.02% return everyday for a year and then losing 10% in a single day - painful, right?

More often than not, if a trading strategy is making steady money and most trades are winners, there’s a good chance you’re in negative skew territory and you haven’t seen the big loss yet.

And the worst part is that the regular daily wins are small enough that folks end up taking leverage to trade these strategies. A negative skew strategy often requires leverage to achieve decent absolute returns when the going is good, but the same leverage will destroy you when things turn sour. Check out these articles on leverage that we've written before: [Leverage in Trading: Long Options](https://algotest.in/blog/leverage-in-trading-long-options/) and [Leverage in Trading: 2.25 Crores in 8 minutes.](https://algotest.in/blog/leverage-in-trading-2-25-crores-in-8-minutes/) ​

### Negative skew in Arbitrage Funds

Now, lets take a look at a Sundaram arbitrage fund to really drive home the point of negative skewness:

Let’s understand this with an example, check out [this website](https://www.sundarammutual.com/Fund/Sundaram-Arbitrage-Fund).

You see a nice 45 degree graph, looks like the arbitrage fund has done well since inception here.

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-1749109135086-compressed.png)

But, the devil is in the details. Let’s change the allocation strategy from monthly SIP to lumpsum. Now, we see a dip in 2018 which was hidden since the SIP smoothened the volatility out:

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-2-1749109151755-compressed.png)

You zoom in on this period and you’ll see that your portfolio fell from a peak of 11,323 to 10,727 from 7th September to 25th September. That’s a crazy annualised return during this period for a low risk fund.

Simple return = (Final Value − Initial Value) / Initial Value

              = (10 717 − 11 323) / 11 323

              = −0.05352 →  −5.352 %

Annualised return = (1 + simple return)^(365 / 19) − 1

                  = (1 − 0.05352)^(365 / 19) − 1

                  ≈ −0.6523   →  −65.23 % per year

It took it close to 18 months to recover its NAV back - you're in an 18 month time drawdown! **Typical negative skew behaviour.**

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-3-1749109216131-compressed.png)

What happened? During the IL&FS crisis, they had invested in DHFL bonds. [Here’s the link to their disclosure.](https://www.sundarammutual.com/pdf2/2019/Docs/SMF_DHFL.pdf) ​

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/b64-1749117768056-compressed.png)

(I guess they haven’t mentioned the arbitrage fund in this pdf, maybe because the pdf was dated before they took a hit on the arb fund? Who knows.)

An arbitrage fund manager only needs 65% in equity, they’re free to invest the remaining 35% elsewhere, which is why this can happen if you’re invested in some bond that defaults.

You can confirm this on [investHQ](https://investhq.in/) by backtesting a “buy and hold” strategy for Sundaram Arbitrage Fund:

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-4-1749118138007-compressed.png)

You see a max drawdown of -5.28% over a 10 year backtest, which is much higher than any other mutual fund in this category. For example, the Tata Arbitrage Mutual Fund has a max drawdown of -0.57%, but it wasn’t around for the 2018 period so maybe it's not a fair comparison.

So, I created this table below, and we can see 18 Arbitrage Funds that existed before this drawdown date, and this is their drawdown.

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/arbiii-1749549058310-compressed.png)

We’ve run a “buy and hold” backtest of every fund in the Arbitrage fund subcategory and created this table.

It seems that Sundaram is the black sheep here. So I guess the SEBI risk category for this fund category is “Low risk”, which is then by default being applied to each fund in the subcategory as well.

Actually, let’s talk about SEBI’s riskometer next.

## Riskometer

I'm sure we're all aware of the SEBI prescribed Riskometer that shows the relative riskiness of each mutual fund.

We’ll do something different here - we’ll try to establish a risk profile by only looking at the historical NAV data, and ignoring the riskometer. It’s also easier to reason about risk of an asset when looking at it relative to the risk of other assets, so let’s compare HDFC MM with Sundaram Arbitrage. (Why HDFC MM? It’s my default cash parking option based on a legacy recommendation from a friend - from an era when I cared very little about my asset allocation and just needed something better than an FD).

Let’s look at their existing fund pages, published on their own websites. We’ve already seen the max drawdown of Sundaram Arbitrage Fund above. Now, let’s look at the max drawdown of HDFC MM, let’s do a 10 year backtest here:

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-5-1749121587790-compressed.png)

It has a much lower max drawdown →

See, it lost a bit of money during the covid period but it gained it back in the next few days. A much lower max drawdown and a much lower max time drawdown as well. With a much higher XIRR, the return of HDFC MM is much higher on a risk-adjusted basis as well.

What’s the SEBI risk category for HDFC Market Money?

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-6-1749121690358-compressed.png)

Again, this is a data-only approach that I’m taking here, data taken out of context could be misconstrued. SEBI has taken a “what’s in it” approach to these funds - they take a bottom up approach where they look at the fund’s mandate, whether it follows SEBI’s mandate for that particular subcategory, and then what’s actually in the mutual fund?

Our top down, data-only approach shows that the relative risk profile is different from the SEBI riskometer between these two funds.

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/mm-1749549138744-compressed.png)

So in the image above, we can see that all funds in the money-market category except one have a lower max DD than the Sundaram arb fund. This isn’t an attack on the Sundaram arb fund - they weren’t the only ones who got caught holding DHFL NCDs (they were rated AAA; don't get me started on AAA ratings), but the point I’m trying to make is that the devil is in the details; nobody really considers “Low risk” to mean negative skew until the tail event arrives.

Since we’re seeing an at-most 35% allocation in non-arbitrage strategies as well, I’m curious to understand how much of the overall return is actually attributed to arbitrage, vs debt. Lets explore that next.

### Arbitrage Fund: How much is actually Arbitrage?

It’s interesting that this fund is called an arbitrage fund, even though most funds have 65%-70% of their assets involved in arbitrage strategies, and the remaining assets are in different bonds and commercial papers. Most of these funds have generated returns in the range of 6%-8%. I’m curious to understand what proportion of these returns are generated using arbitrage and what proportion of returns are generated using the bonds.

Here are two scenarios which I think are possible:

Example 1:

Allocation

Instrument

Expected Return (CAGR)

Weighted Contribution

65%

Arbitrage Strategies

4.5%

0.65 × 4.5% = 2.93%

35%

10 % YTM bonds

10.15%

0.35 × 10.15% = 3.55%

Total Portfolio CAGR

≈ 6.48%

A higher chunk of return is actually coming from bonds, so this shouldn’t really be labelled as an arbitrage fund.

Example 2:

Allocation

Sleeve

Expected Return (CAGR)

Weighted Contribution

65%

Pure arbitrage positions

7%

0.65 × 7% = 4.55%

35%

Cash / collateral (e.g., short-term bonds)

7%

0.35 × 7% = 2.45%

Total Portfolio CAGR

≈ 7%

A higher chunk of returns are being generated from actual arbitrage.

It would be interesting to know if we can get this data from anywhere to actually quantify the source of returns.

Let’s look at TATA, which is generating a 6.48% CAGR since inception. Going to its official website and trying to download the current holdings (ignoring the fact that the holdings PDF is dated 30 Sept, 2023, which is ~2 years ago), I see that this is the breakdown of the holdings:

Arbitrage Component

The arbitrage portion includes equity stocks paired with equivalent short positions in futures, which hedge out market risk. The fund shows:

- **Hedge Positions:** 68.52% long in stocks, matched by -68.97% in futures

- These net to near-zero exposure but represent capital deployed in arbitrage trades

- **Total arbitrage exposure:** approximately **68.52% of NAV**


### **Debt & Money Market Instruments**

- **Government securities:** 0.65%

- **Non-convertible debentures/bonds:** 5.51%

- **Money market instruments (e.g., CPs):** 4.31%

- **Mutual fund units (Tata Money Market & Treasury Advantage):** 17.80%

- **TREPS and Repo:** 5.72% + 2.05% = 7.77%


**Total debt & related instruments:** = 0.65% + 5.51% + 4.31% + 17.80% + 7.77%

**= 36.04% of NAV**

Component

% of NAV

Arbitrage Strategies

68.52%

Debt Instruments

36.04%

Net Current Liabilities

-4.56%

Total

100.00%

So, approximately:

- **~68.5%** of the fund is deployed in arbitrage strategies

- **~36%** is parked in debt/money market instruments (some of this is likely used for margin funding as well)


So it appears that 68% of the fund is cash-future arbitrage. Lets actually simulate a cash-future trade to see what kind of return we can generate from this trade.

You can open up the AlgoTest simulator and try to mimic an arbitrage strategy by buying shares and selling the future. Let’s take this trade with RELIANCE, which is TATA’s largest holding in the arbitrage book (approx 4.5%), and let’s take this trade on Rollover day, i.e. monthly expiry. We’ll take 24th April, 2025 as the date. A cursory glance difference between the future price and the underlying price shows that the spread ranges from ~Rs. 5 to Rs 8.50 during the day. We’re only looking at LTP at 1-min intervals (this is how the simulator data shows it).

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-7-1749123100868-compressed.png)

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-8-1749123193119-compressed.png)

Reliance Cash-and-Futures Arbitrage (35-day expiry)

**09:27 AM**

- Spot: ₹1,293.0
- Futures: ₹1,301.5
- Spread captured: **₹8.5**
- Position: 500 shares → gross P/L **₹4,250**(8.5 × 500)
- Capital tied up: ₹6,46,500 (1 293 × 500)
- **Annualised return** (before costs): (4,250 ÷ 6,46,500) × (365 ÷ 35) **≈ 6.8%**

**01:55 PM**

- Spot: ₹1,299.4
- Futures: ₹1,304.7

- Spread captured: **₹5.3**
- Position: 500 shares → gross P/L **₹2,650** (5.3 × 500)
- Capital tied up: ₹ 6,49,700 (1,299.4 × 500)
- **Annualised return** (before costs): (2,650 ÷ 6,49,700) × (365 ÷ 35) **≈ 4.2%**

Locking in the morning spread delivers a pre-cost annualised yield of about 6.8%, whereas waiting until early afternoon trims it to roughly 4.2%. Figures exclude brokerage, taxes, and other statutory charges.

Expenses (without brokerage)¹ = **455.60/-**

After costs, the returns reduce, i.e. from 4.2%, it reduces to 3.52%, and from 6.8%, it reduces to 6.12%.

Entry Time

Gross P/L (₹)

Net P/L after Costs (₹)

Capital Deployed (₹)

Annualised Return (Net)

Annualised Return (Gross)

09 : 27 AM

4,250

3,794.4

646,500

6.12 %

6.86 %

01 : 55 PM

2,650

2,194.4

649,700

3.52 %

4.25 %

#### Note:

We’re assuming that the cash required to short the future contract is 0, as you can potentially pledge your debt holdings and the underlying securities to get some sort of margin benefit. But you’ll need some cash margin in order to handle the daily mark-to-market settlement that comes from the futures.

Also there’s costs associated with actually putting these positions on, using some sort of arbitrage capturing hardware/software.

So, we would love the opportunity for an AMC or fund manager of some arbitrage fund to actually explain how the sausage is made here, and how much have we gotten correct here in our analysis.

**TL;DR:**

Spreads are tight, a large chunk of return is coming debt and the ability to pledge the debt to get lower cash margin requirements. So, if interest rates decline, we should see a decline in the future rate of return offered by these funds because of bond rates reducing as well as the arbitrage opportunity reducing due to the cost of carry reducing.

(Cost of carry = futures price – spot price. It’s driven by interest rates. Higher the interest rate, higher the cost of carry, higher the potential return offered by these funds.)

### Conclusion:

Arbitrage funds could be a  “low-risk, tax-efficient” shortcut, but you’re getting some “negative skew” sprinkled in it as well. Finally, before investing, you should look into:

**Historical CAGR and volatility** – check the Sharpe ratio, not just headline returns.

**Maximum drawdown** – even “market-neutral” products can suffer setbacks.

**Non-arbitrage allocation** – if only 65 % sits in true arb trades, where is the other 35 % parked?

**And, it would be great if SEBI could ask the AMCs to post what proportion of the 6-8% XIRR is actually coming from arbitrage vs the bond portfolio?**

### Post credits:

Arbitrage Mutual Funds keep ~15–30 % in debt to supply margin and meet redemptions. Reaching for a few extra basis points can backfire:

- Credit events (already covered above): Sundaram Arbitrage Fund etc. held AAA-rated DHFL paper that was marked down 75 % when DHFL defaulted in June 2019, slicing ~5 % off the fund’s NAV overnight.
- Liquidity freezes: If spreads go negative and the fund faces large redemptions, managers may dump the debt sleeve at a discount just to raise cash, crystallising losses that equity convergence would otherwise have covered. This happened during covid. Check it out [here](https://economictimes.indiatimes.com/mf/analysis/arbitrages-turn-negative-funds-lose-40-of-assets/articleshow/75173063.cms).

Expenses Breakdown¹

Charge Type

Amount (₹)

Clearing Charges\*

17.70

IPFT

3.90

STT

292.65

Stamp Duty

32.39

SEBI Charges

5.19

Exchange Charges

87.14

GST (18 %)

16.62

Total

455.60

\\* Clearing charges will only applicable, if buy/sell date of Cash is different (15\*1.18 = 17.70).


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## Arbitrage Funds - A Deep Dive
Published: 2025-06-02
Category: Insights by Raghav Malik
Category URL: https://investhq.in/blog/category/insights-by-raghav-malik/
Tags: Arbitrage Funds
Tag URLs: Arbitrage Funds (https://investhq.in/blog/tag/arbitrage-funds/)
URL: https://investhq.in/blog/arbitrage-funds-deep-dive/

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/add-a-subheading-2400-x-1600-px-2-1749125673575-compressed.jpg)

Arbitrage, if I have to really keep it simple, is to buy an asset for cheap in one market and sell the same asset for a higher price in another market. Exploiting price differences between the cash and future market is an example of an arbitrage opportunity. These are typically small but can be systematically captured.

You can read our quick intro to [arbitrage funds](https://investhq.in/blog/arbitrage-funds-in-india/).

My goal with this article series is to take a data-driven approach to evaluate arbitrage funds. First, lets talk about the marketing message associated with Arbitrage Funds:

_Q: Why Should You Invest in Arbitrage Funds?_

_A: Whenever you see any article or piece of content asking this question, the usual response is:_

1. **Low Risk Profile**
   1. Less sensitive to market volatility compared to pure equity funds.
   2. Ideal for conservative investors looking for capital protection with modest growth.
   3. Volatility is dampened due to hedging with futures contracts.
2. **Tax Efficiency**
   1. Treated as equity funds (due to >65% equity exposure), offering better tax treatment than debt funds.
      1. Long-Term Capital Gains (LTCG): 12.5% on gains exceeding ₹1.25 lakh per financial year, holding period is ≤ 12 months
      2. Short-Term Capital Gains (STCG): 20%, holding period is ≤ 12 months
3. Diversification Benefit
   1. Invest in a mix of equity and derivatives.
   2. Strategy reduces correlation with the equity market, providing portfolio stability.
4. **Potential in Volatile Markets**
   1. Arbitrage spreads **widen during volatility**, increasing potential profits.

We’ll explore each of these points one by one by looking at some actual data.

### Low Risk:

Less sensitive to market volatility compared to equity funds.

But is it really low risk? Let's dive in - we’ll use two measures of risk here - one is volatility and second is maxDD (max drawdown). Both are somewhat correlated, but sometimes you can see higher drawdowns in assets with lower volatility (we’ll discuss this in a later article)

Lets pick two representative mutual funds, one each from the arbitrage and flexi cap category. I’ll pick these two specifically coz I’m invested in them personally:

- PPFAS flexi for Equity flexicap, and
- Tata Arbitrage for Arbitrage​​

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-1748956760945-compressed.png)

Yup, the arbitrage fund has a much lower annualised volatility than the flexi cap fund.

We can also backtest the 10-year return for arbitrage funds and check out the volatility AND max drawdown of each fund in the arbitrage subcategory  [investHQ](https://investhq.in/).

This is what data shows.

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/arb-1749016385402-compressed.png)

You’ll notice that besides Sundaram’s arbitrage fund, all other arb funds have a max DD of less than 1%. (More details on what happened with Sundaram Arbitrage Fund in [this article](https://investhq.in/blog/arbitrage-funds-low-risk-tax-efficient/).)

A same table generated from the backtest for flexi cap funds shows that if we use volatility and maxDD to quantify risk, the arbitrage fund subcategory is far less riskier than pure equity funds. Here’s the flexi cap table:

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/flexi-1749016452320-compressed.png)

Now let’s look at:

### Tax Efficiency:

Treated as equity funds (due to >65% equity exposure), offering better tax treatment than debt funds.

Before we elaborate on this point, lets first look at

### SEBI's classification for Arbitrage Funds:

Under SEBI's mutual fund classification framework, Arbitrage Funds fall under the Hybrid category, and are defined as:

"Schemes that invest at least 65% of total assets in equity and equity-related instruments on an average monthly basis in arbitrage opportunities."

### What about the remaining 35%?

The remaining (up to 35%) assets can be invested in other instruments, subject to the fund’s investment objective and scheme information document (SID). There is no specific restriction from SEBI on the exact instruments for this 35%, so in practice:

- Funds can invest in debt instruments (e.g., money market instruments, treasury bills, corporate bonds)
- Funds may hold cash and equivalents
- Some might take limited exposure to unhedged equity positions, although this is typically very minimal in true arbitrage funds to avoid risk

SEBI has classified Arbitrage funds in the hybrid category with the rule that minimum 65% of the assets will be invested in equity and equity-related instruments.

Most arbitrage funds I’ve seen so far invest the remaining 35% in debt-like securities, which could be their own AMC’s money-market or liquid mutual funds, NCDs, etc.

**But why 65%? What’s the significance of 65%?**

It’s because of tax reasons. The government says if holding is greater than 65% in equity, then it should be taxed as equity, which is favourable for HNI’s who are in the higher tax bracket.

How are they taxed?​

- Long-Term Capital Gains (LTCG): 12.5% on gains exceeding ₹1.25 lakh per financial year, holding period is ≤ 12 months
- Short-Term Capital Gains (STCG): 20%, holding period is ≤ 12 months

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-2-1748957200500-compressed.png)

### Diversification Benefit

Offer diversification benefits by investing in a mix of equity and derivative instruments, which helps spread risk and enhance portfolio stability. Strategy reduces correlation with the equity market, providing portfolio stability.

What I think is most funds have at least 65% of their AUM deployed in cash vs future carry arbitrage strategies, whose returns should be relatively uncorrelated with the broad equity market, so this is correct in theory.

### Potential for Profit in Volatile Markets:

Can be particularly lucrative during periods of increased market volatility, as they profit from price discrepancies across different markets.

This is an interesting observation. Do future prices deviate more than the spot price during market uncertainty and periods of high volatility? Yes they do (atleast in theory).

_If this is true, then arbitrage funds will make more money during that period._ Let’s verify this.

Rolling XIRR over a 2-month period will show a clear picture of how much better the fund performs during volatile periods.

Here is a point estimate from that rolling return chart, where you see the arb fund returns 8.5% annualised, vs a -52% XIRR for NIFTYBEES during the COVID period:

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-3-1749015924619-compressed.png)

The Tata Arbitrage fund has returned 6.5% XIRR over its lifetime, see here:

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/unnamed-4-1749016060701-compressed.png)

So based on this single data point, yes the arbitrage fund outperformed NIFTY, as well its own historical performance (8.5% vs 6.5%).

We decided to run a backtest for the COVID period, and here is the XIRR for the arbitrage funds during that time (see image below):

**_(01-03-2020 to 01-05-2020 and 10-year comparison)_**

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/arbii-1751272309559-compressed.png)

Bottom Line:

It seems like they all beat NIFTY during the financial crisis (which they should!) BUT when it comes to beating their own 10yr performance, plenty of them underperformed during that period.

So we looked at each of these “virtues” of an arbitrage fund with a little bit of data, and it seems that arb funds do indeed hold up strong when compared to more liquid debt fund categories like money-market and liquid funds, but not all of them do as well during periods of volatility.

In the next article of the series, we’ll go even [deeper into arbitrage funds](https://investhq.in/blog/arbitrage-funds-low-risk-tax-efficient/) \- where we uncover some hidden risks of investing in these instruments.


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## Arbitrage Funds in India: A Quick Guide with Example
Published: 2025-06-02
Category: Insights by Raghav Malik
Category URL: https://investhq.in/blog/category/insights-by-raghav-malik/
Tags: Arbitrage Funds
Tag URLs: Arbitrage Funds (https://investhq.in/blog/tag/arbitrage-funds/)
URL: https://investhq.in/blog/arbitrage-funds-in-india/

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/add-a-subheading-2400-x-1600-px-1749125456912-compressed.jpg)

1\. What Are Arbitrage Funds?

Arbitrage funds are hybrid mutual funds that aim to generate low-risk, debt-like returns by exploiting price differences between the cash (spot) market and the futures market for the same stock as their primary strategy. These differences are typically small but can be systematically captured.

To qualify as equity funds for taxation purposes, arbitrage funds maintain at least **65% exposure to equity-related instruments**, even though their return profile behaves more like fixed income. The rest is usually parked in debt funds. More details can be found in [this article](https://investhq.in/blog/arbitrage-funds-deep-dive/).

### 2\. How Do Arbitrage Funds Work?

Here's how a typical arbitrage trade works:

Suppose Reliance Industries is trading at ₹1272.3 in the cash market.

At the same time, its futures contract (say, 41 days to expiry) is trading at ₹1280.4.

An arbitrage fund would:

- Buy 500 shares of Reliance in the cash market.
- Sell 1 Reliance futures contract (lot size = 500) at ₹1280.

At expiry, futures and cash prices converge. The fund then:

- Sells the 500 shares in the cash market.
- Buys back the futures contract.

### Calculation:

**Reliance Cash Pric** e = ₹1272.3

**Reliance Futures Price (41 DTE)** = ₹1280.4

**Spread** = ₹8.1

**Lot Size** = 500 shares

**Profit** = ₹8.1 × 500 = ₹4,050 (before costs)

**Capital Required**: For such hedged arbitrage trades, margin requirements are around ₹7,50,000 per lot.

### Return:

**Absolute Return** = ₹4,050 / ₹7,50,000 = 0.54%

**Annualised Return (CAGR-style over 41 days):**

(1 + 0.0054)^(365/41) - 1 = (1.0054)^8.902 - 1 = 1.0502 - 1 = 0.0502 ≈ **5.02%**

This is pre-cost. Post-tax and post-cost returns might be slightly lower, but for high-net-worth investors or institutions, this offers a tax-efficient alternative to fixed deposits and liquid funds.

This locked-in spread is considered low-risk if both legs are held till expiry.

**You can see a more detailed calculation of this with real market data in this [article](https://investhq.in/blog/arbitrage-funds-low-risk-tax-efficient/).**

* * *

### 3\. Taxation of Arbitrage Funds (Post-Budget 2024)

Despite offering fixed-income-like returns, arbitrage funds are taxed as equity mutual funds, providing a significant advantage over debt funds and fixed deposits, especially for those in higher tax brackets.

Effective from July 23, 2024, the tax structure is as follows:

Holding Period

Tax Treatment

≤ 12 months

20% Short-Term Capital Gains (STCG)

\> 12 months

12.5% Long-Term Capital Gains (LTCG) on gains exceeding ₹1.25 lakh per financial year

These changes were introduced in the Union Budget 2024 to simplify and rationalize the capital gains tax framework.

So if you’re in the 25% or 30% tax bracket, it makes sense to park your short term cash in arbitrage funds, rather than in traditional debt instruments.

* * *

### 4\. Who Should Invest in Arbitrage Funds?

Arbitrage funds are ideal for:

- Investors in high tax brackets seeking low-risk returns
- Individuals looking to park money for 3–6 months
- Those who want liquidity with tax efficiency

They are _**not suitable**_ for investors seeking **_high returns or long-term capital growth._**

* * *

### 5\. Risks to Consider

- Diminishing spreads in low-volatility markets
- Execution slippage or inability to completely hedge
- Costs like brokerage, STT, stamp duty, and GST eating into returns

While considered low-risk, arbitrage funds aren't entirely risk-free. Proper fund management is essential to ensure predictable, tax-optimized returns.

**On top of this, there are some non-obvious risks we discuss in our article, [Arbitrage Funds - A Deep Dive](https://investhq.in/blog/arbitrage-funds-deep-dive/).**

* * *

### Conclusion

Arbitrage funds offer a compelling option in a high-tax environment for generating low-risk, short-term returns. With favorable equity taxation and a built-in hedging mechanism, they function like the best of both worlds: equity classification with fixed income behavior.

In a world where tax efficiency is paramount, arbitrage funds are a tool every serious investor should consider.


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## Introducing InvestHQ - A Mutual Fund Simulator for the Curious Indian Investor
Published: 2025-04-23
Meta Title: Introducing InvestHQ - A Mutual Fund Simulator
Meta Description: Explore InvestHQ – Analyse 25000+ Mutual Funds and Backtest them using our FREE Mutual Fund Calculator for Backtesting. Optimise your MF portfolio for better returns.
URL: https://investhq.in/blog/introducing-investhq/

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/add-a-subheading-2400-x-1600-px-1747655818378-compressed.png)

_(TL;DR: Build any MF portfolio ➞ test lumpsum, SIP, or auto‑rebalance ➞ see how it might have fared in the past. Free for now - give it a spin and tell me what breaks.)_

* * *

## **Why another “Mutual Fund Calculator”?**

![](https://assets.superblog.ai/site_cuid_cm9txj18z00p514n5purml2cp/images/mf-1745485179765-compressed.png)

Because most calculators stop at **static CAGR tables**. Markets - and portfolios - don’t move in straight lines, so why should our tools?

[InvestHQ](https://investhq.in/) lets you:

1. **Mix & match any Indian mutual funds** into a portfolio you actually care about.

2. **Replay history**: Lump‑sum or SIP from any start date to any end date.

3. **Stress‑test rebalancing** in three flavours:

\- Frequency‑based (monthly, quarterly, yearly…)

\- Band‑based (rebalance only if a weight drifts outside ±X%)

\- Hybrid (bands checked on your chosen frequency)

4. **Compare the ride**: A smoother volatility profile often costs a few - or a few dozen-basis points of return. Now you can measure that trade‑off, not guess.

_Exit‑load logic, full tax modelling, and selectable transaction‑cost assumptions are coming soon._

* * *

## **The back‑story (a confession)**

I’ve spent 15 years as an options market‑maker and HFT technologist - hip‑deep in volatility, Greeks, and nanoseconds. Yet my personal capital? Mostly parked in money‑market funds.

- **2008 crash trauma:** I cut my teeth on a short‑vol desk during the GFC while reading Shiller’s Irrational Exuberance. Valuations looked doomed forever.

- **Perma‑bear inbox:** I subscribed to every newsletter that screamed “SPY overvalued at 200!” and missed a decade‑long melt‑up.

- **Debt‑heavy portfolio:** Fast‑forward to 2025 in India - I’ve got rupees to deploy and a risk budget stuck in 2009.

Building InvestHQ is my way to **face the data** instead of the doom‑scroll. If a tool can help me shake analysis paralysis, maybe it can help others, too.

* * *

## **What makes InvestHQ different?**

Features

Most Calculators

InvestHQ

Multiple funds in one run

1-2 max funds

Unlimited (mix equity, debt, hybrid)

SIP simulation

Basic

Any start/end date, variable amount, step-up SIP, Smart SIP that channels new money to under-weight funds before any selling

Rebalancing Options

Rare

Frequency-based, band-based, or hybrid (bands tested on the chosen frequency)

* * *

### **How to use it in 60 seconds**

1. **Pick funds:** Search by name or category.

2. **Choose mode:**

\- Lump‑sum → One‑shot investment.

\- SIP → Monthly, weekly, custom date. Smart‑SIP behaves exactly like a diligent investor: new money first restores target weights, then tops up proportionally.

3. **Flip the “Rebalance” switch** and set frequency and/or bands.

4. **Hit Run**: Graphs update; metrics refresh.

5. **Tinker**: Change weights, add/delete funds, compare runs side‑by‑side.

Full walkthrough video ➞ [**Watch here**](https://youtu.be/LUNIcRRsMtY?si=6UwF05_7SIPP2RX5).

* * *

## **Caveats & realistic expectations**

- **Past ≠ future**: We’re replaying history, not predicting it.

- **Data quirks**: Some funds merge or change mandate; we handle most cases, but yell if we can’t.

- **Transaction costs & tax impact**: Not modelled yet - both will be toggleable soon.

* * *

## **Call to action**

1\. Check it out at [InvestHQ](https://investhq.in/) (desktop & mobile).

2. **Tell us what’s confusing or broken** \- screenshots help!

* * *

## **Final thoughts: from trading ticks to compounding bricks**

Building pipes for HFT taught me the beauty of micro‑edges. Investing, though, is the macro edge: patience, diversification, and letting capitalism do the heavy lifting. [InvestHQ](https://investhq.in/) is my attempt to bridge those mindsets - quant‑rigour meets long‑term common sense.

Hope it helps you, too.

**\- Raghav Malik**

_(Founder & CEO, AlgoTest)_


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