Who should consider investing in income plus arbitrage FoFs?

Savers with an investment horizon of 24-30 months, seeking capital preservation, tax efficiency and slightly higher post-tax returns than fixed deposits, are allocating money to the income plus arbitrage fund of funds (FoF) category.

WHAT IS AN INCOME PLUS ARBITRAGE FUND OF FUND (FOF)?
An income plus arbitrage fund of fund (FoF) is an open-ended mutual fund scheme that primarily invests in a mix of two distinct categories: debt-oriented schemes and arbitrage schemes. The objective of the FoF is to provide a combination of stability and income from the debt portion, along with tax efficiency and low-risk returns from the arbitrage portion. Mutual funds introduced this category of FoFs to take advantage of tax rule changes that came into effect on April 1, 2025.


HOW MANY SCHEMES ARE THERE IN THIS CATEGORY AND HOW MUCH MONEY DO THEY MANAGE?
There are 22 schemes in this category, managing assets worth `23,455 crore as of May 31, 2025, according to Value Research. The category has delivered an average return of 5.56% over the past year.

WHERE AND HOW DOES THIS SCHEME ALLOCATE MONEY?
Income plus arbitrage FoFs generally allocate a little less than 65% (typically 50-65%) of their assets to debt mutual fund schemes, with the balance invested in equity arbitrage schemes (typically 35-50%). The debt portion aims to generate stable returns and income by investing in underlying debt schemes of the fund house, which may include a mix of accrual and duration strategies. The allocation across these schemes is actively managed by the fund manager based on his view of interest rates. The arbitrage portion is invested in arbitrage schemes offered by the fund house, which seek to capitalise on price differences in the same security between the cash and futures markets through simultaneous buying and selling. The FoF may invest in debt and arbitrage schemes of its own fund house or in schemes managed by other fund houses.

WHO SHOULD CONSIDER SUCH A FUND?
Since these schemes do not invest in either equity or precious metals directly, they are considered low-risk strategies with relatively low volatility. 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.

WHY IS THE INCOME PLUS ARBITRAGE FOF POPULAR AMONG WEALTHY INVESTORS? HOW IS IT TAXED?
The category is gaining popularity, particularly among wealthy investors, because of the tax efficiency. By maintaining the prescribed exposure to equity-related instruments through arbitrage funds, the FoF qualifies for long-term capital gains (LTCG) taxation if held for more than 24 months. Gains are taxed at 12.5%, compared with debt mutual funds and fixed deposits, where returns are taxed at the investor’s applicable income-tax slab rate.