Arbitrage funds are hybrid mutual funds that generate returns from temporary price differences across markets. According to The Hindu, these funds systematically buy stocks in the cash market at lower prices and sell corresponding futures contracts at higher prices, or exploit small price differences across exchanges by buying on NSE and selling on BSE. SEBI classifies arbitrage funds as equity-oriented funds requiring at least 65% gross exposure to equities, with unutilized portions invested in short-term debt instruments.
Market volatility significantly increases arbitrage opportunities, as reported by The Hindu. Researcher Manikandan Chandran from Wincredible Technologies explains that when markets are volatile, price mismatches across exchanges or between spot and derivatives markets tend to increase. In relatively calm markets, such differences may be smaller or vanish quickly, leaving limited spreads or none at all.
Arbitrage funds offer relatively stable, moderate returns rather than high-growth strategies, according to The Hindu analysis. Researcher Manikandan notes that most long-running arbitrage funds have delivered 6%-7% annualized returns on average since inception. The strategy is not entirely risk-free, as returns depend on pricing gaps availability and may be modest when spreads are narrow or opportunities are scarce.
Arbitrage funds are suitable for investors seeking relatively stable returns without market predictions, as reported by The Hindu. These funds are particularly considered during uncertain or volatile market phases when pricing gaps may arise more frequently. However, investors aiming for aggressive long-term growth may find these funds less suitable, as the strategy is not designed for high equity-style growth.
Arbitrage funds offer market-linked flexibility with easier redemption compared to fixed deposits, according to The Hindu. Manikandan notes that while FDs deliver similar returns, arbitrage funds provide a more flexible alternative with generally no premature withdrawal penalties. The strategy works within brief moments of market imbalance, capitalizing on temporary price spreads without relying on market direction predictions.