Arbitrage MF returns to face the squeeze with rise in STT

Returns from arbitrage funds — a popular category among affluent investors — are set to shrink 25-35 basis points after the government in the budget proposed to raise the securities transaction tax (STT) on equity derivative trades. As these schemes aim to benefit from the price anomalies between stocks and stock futures, an increase in transaction taxes in equity futures eats into the gains.

With STT on futures sales rising from 2 basis points to 5 basis points, the annualised transaction cost on the arbitrage component is estimated to climb 25–35 basis points (0.25%-0.35%). Over the last year, arbitrage funds have delivered an average return of 6.82%.

“We estimate returns from arbitrage funds to come down by 32 basis points annually due to higher STT on futures transactions,” says Niranjan Avasthi, senior vice president, Edelweiss Mutual Fund.


The category managed ₹2.78 lakh crore as of December 31, 2025, and saw net inflows of ₹72,318 crore over the past 12 months.
Arbitrage funds earn a spread by buying shares in the cash market and selling corresponding futures. Fund managers roll over stock futures every month, and with churning 10–20% of the book to capture new pricing gaps, result in frequent trades.

“Fund managers hold an average of 65-75% in arbitrage positions with the balance in fixed income. As the cost of sales of futures positions increases 3 basis points, the annual impact on returns can be 25-27 basis points,” says Deepak Gupta, fund manager, Invesco Mutual Fund.

“Rich investors are attracted to arbitrage for its tax efficiency. Many use the category to park money for short-term goals or to stagger their investments into equity,” says Gaurik Shah, senior vice president — Equity Investments, Mirae Asset Investment Managers (India).

Though the higher taxes on stock futures could squeeze returns, it is unlikely to erode its popularity primarily because of lower tax outgo. Gains are taxed as capital gains — at 20% if held for less than a year and 12.5% thereafter. By contrast, returns from deposits or debt funds are taxed at slab rates, which can reach 30% for high-income investors.

“Even after this, if both arbitrage and liquid earn 7%, the post-tax returns for one who pays 30% tax bracket in an arbitrage fund held for a year or more will be higher by 94 basis points than a liquid fund,” said Avasthi.