Explained: What are income plus arbitrage FoFs and why are wealthy investors buying them?

Savers with a 24-30 month investment horizon seeking capital preservation, tax efficiency and slightly higher post-tax returns than fixed deposits are increasingly allocating money to income plus arbitrage fund of funds (FoFs), according to an ET Bureau report.

An income plus arbitrage fund of funds (FoF) is an open-ended mutual fund scheme that primarily invests in a mix of two categories: debt-oriented schemes and arbitrage schemes.

The category aims to offer the stability and income potential of debt funds, combined with the tax efficiency and relatively low-risk returns of arbitrage funds. Mutual funds introduced these FoFs to benefit from the tax rule changes that came into effect on April 1, 2025.

Financial planners believe these schemes are suitable for investors looking to allocate a portion of their portfolio to fixed income while benefiting from tax efficiency, typically with an investment horizon of 24-30 months.

The category is gaining traction, particularly among wealthy investors, because of its tax efficiency. By maintaining the prescribed exposure to equity-related instruments through arbitrage funds, these FoFs qualify for long-term capital gains (LTCG) taxation if held for more than 24 months.

Income plus arbitrage FoFs typically allocate 50-65% of their assets to debt mutual fund schemes, with the remaining 35-50% invested in equity arbitrage schemes.

The fund manager actively manages the allocation across these schemes based on their view of interest rates.