Market Volatility Rises Amid Iran-US Conflict: Are Arbitrage Funds A Better Option?

As market volatility continues to keep investors on edge, arbitrage funds are emerging as a relatively stable option within portfolios. These funds operate by capturing price differences between the cash and derivatives markets—buying in one and selling in the other—to lock in low-risk returns.

Unlike traditional equity funds, their performance is less dependent on market direction and more on the spreads available at a given time.

How Arbitrage Funds Work

Arbitrage funds aim to benefit from temporary pricing inefficiencies. During volatile phases, such opportunities tend to increase, allowing fund managers to generate consistent, though moderate, returns. Since positions are typically hedged, the overall risk remains closer to debt instruments rather than equities.

Stability with Tax Advantage

According

to Arjun Guha Thakurta, Executive Director at Anand Rathi Wealth, arbitrage funds can add stability, liquidity, and tax efficiency to a portfolio. He explains that these funds offer equity-like taxation while maintaining a relatively low-risk profile. This makes them a suitable alternative for the debt portion of a portfolio, especially for investors in higher tax brackets seeking better post-tax returns.

Ideal Investment Horizon

Thakurta suggests that investors should consider arbitrage funds primarily for the medium to long-term segment of their debt allocation. For shorter durations—typically less than 3 to 6 months—liquid or short-duration funds may be more appropriate due to their higher liquidity and stability.

Who Should Invest?

From a tax perspective, arbitrage funds are more beneficial for investors in higher tax slabs due to favourable capital gains treatment. On the other hand, those in lower tax brackets may find traditional debt options like target maturity funds more rewarding, as they are taxed according to income slabs.

Not a Growth Substitute

Importantly, arbitrage funds should not be treated as growth-oriented investments. As Thakurta notes, their primary role is to deliver low-risk, stable returns rather than equity-like growth. Hence, they are best used as a complementary component within the debt portion of a diversified portfolio.