Price Difference = Potential Opportunity? Learn How Arbitrage Mutual Funds Seek to Benefit From Price Differences

Arbitrage mutual funds are hybrid mutual funds that follow an “arbitrage strategy” and invest at least 65% of their total assets in equity and equity-related instruments. (Source: SEBI)

The potential arbitrage fund performance are linked to the “spread” between the bid (buying) price and ask (selling) price, net off transaction costs and other expenses.

In arbitrage, the “gap” between two market prices is viewed as a potential opportunity to generate return. Arbitrage mutual funds are designed around this principle. They open simultaneous positions in the cash and derivatives markets to seek potential benefits from temporary price differences. 

Want to understand in detail? Read this article to learn what arbitrage funds are, their primary features, and how the arbitrage strategy works.

Under the SEBI Circular, Rationalisation and Categorisation of Mutual Fund Schemes, dated February 26, 2026, Arbitrage Funds are grouped under the category of “hybrid” funds. 

An arbitrage fund is an open-ended scheme following an “arbitrage strategy” and investing at least 65% of its total assets in equity and equity-related instruments. 

For those unaware, an arbitrage strategy involves taking advantage of a potential price difference for the same securities in different markets. 

Note: As per SEBI, an arbitrage fund is NOT permitted to invest in InvITs. Furthermore, if the scheme takes a “defensive position” (say, due to market conditions or limited arbitrage opportunities), such a situation must be specified in the asset allocation of  the Scheme Information Document (SID). 

Additionally, the scheme may invest in government securities with a maturity of less than one year, repos in government bonds, and certificates of deposit (CDs). It may also invest in units of liquid funds, money market funds, or schemes with a Macaulay duration of less than one year to meet liquidity and margin requirements.

Primary Features of Arbitrage Mutual Funds 2026

Generally, a conventional equity fund seeks to earn potential returns from a stock's price appreciation. In contrast, an arbitrage fund primarily seeks to earn potential return from the “price difference” of the same securities in two different markets by taking related positions (usually opened in the cash and derivatives markets). 

For a better understanding, let’s check out the several features of arbitrage funds:

The basic idea is to “simultaneously” buy an asset/security in the market where it is available at a lower price and sell it in another market where it is trading at a higher price. The difference between the two prices represents the arbitrage opportunity. 

In this way, the arbitrage fund’s performance comes from the “price difference” between the two positions in two different markets, subject to transaction costs and other expenses. Want to gain more clarity? Let’s understand this process in detail:

Step 1: Identify a Price Difference

fund managers usually look for a stock whose spot price and futures price are different. For example, 

• Suppose a stock is trading at ₹100 in the cash market.
• Whereas, its futures contract is available at ₹102. 
• The ₹2 difference may provide an arbitrage opportunity.

Note that the entire price difference of ₹2 will not become the fund's profit. The arbitrage funds also considers brokerage, transaction costs, and other applicable charges.

Step 2: Buy in the Cash Market

Continuing from the above example, the fund manager buys the stock in the cash market at ₹100. At the same time, it takes a position in the futures market. This creates two “linked positions” based on the same stock.

Step 3: Sell in the Futures Market

Later, the fund sells the stock's futures contract at ₹102. In simple terms, the fund manager has bought the stock for ₹100 and agreed to sell it through the futures contract at ₹102.

This transaction locks the potential price difference (of ₹2 per share) between the two markets, subject to transaction costs and the terms of the futures contract.

What May Happen When Arbitrage Opportunities Are Limited?

Arbitrage opportunities are not always available. When the fund manager does not find enough suitable arbitrage opportunities, the scheme may hold part of its assets in the debt instruments as permitted by SEBI under the scheme category. 

For an arbitrage fund, investments in debt and money market instruments may include:

• Government securities with a maturity of less than one year
• Repos in government bonds
• Certificates of deposit (CDs), and 
• Units of liquid funds, money market funds, or schemes with a Macaulay duration of less than one year (to meet liquidity and margin requirements). 

This allows the scheme to deploy funds while it waits for suitable arbitrage opportunities. 

So, now you know the answer to “Price Difference = Potential Opportunity?”. Arbitrage mutual funds are hybrid schemes . They invest at least 65% of their total assets in equity and equity-related instruments and follow an “arbitrage strategy” to seek potential benefit from the potential price differences between the cash and futures markets. 

The fund generally buy a security at a lower price in the cash market and sell its futures contract at a higher price, with the positions designed to capture the price difference as the two prices converge in two different markets. 

However, arbitrage opportunities are not always available. In such situations, the fund may deploy its assets in permitted instruments, including government securities with a maturity of less than one year, repos in government bonds, certificates of deposit (CDs), and units of liquid funds, money market funds, or schemes with a Macaulay duration of less than one year to meet liquidity and margin requirements.

For more information, you can visit www.tatamutualfund.com/deshkarenivesh. The Investor Service Centre of Tata Asset Management Pvt. Ltd. is located at Mulla House, Ground Floor, 51, M.G. Road, Near Flora Fountain, Mumbai – 400 001, Maharashtra. The office hours are Monday to Friday, 9:00 AM to 5:30 PM. For assistance, you can also call (022) 6282 7777 from Monday to Saturday, 9:00 AM to 5:30 PM, or email service@tataamc.com

1. How do arbitrage mutual funds work?

Arbitrage funds follow an “arbitrage strategy”. The fund managers usually look for opportunities where the same security is available at different prices in the cash and futures markets. 

Generally, the scheme buy at the lower price and sell at the higher price to capture the potential price difference in two different markets.

2. What is the importance of liquidity for arbitrage funds?

As per industry understanding, liquidity allows an arbitrage fund to enter and exit positions in the cash and derivatives markets with greater ease. 

Besides, “adequate liquidity” may also reduce the risk of significant price slippage between the intended trade price and the actual execution price. 

3. What is the role of cash and derivative segments in arbitrage funds?

Generally, an arbitrage fund buys a stock in the cash market at a lower price and, at the same time, sells its futures contract at a higher price. The difference between these two prices in two different markets creates the arbitrage opportunity. 

As the cash and futures prices converge, the fund seeks to capture this price difference, after applicable costs and expenses.

4. Are arbitrage mutual funds suitable for conservative investors?

 arbitrage funds may be considered by investors seeking lower “market-direction” exposure than conventional equity funds. That’s largely because the arbitrage strategy generally uses offsetting cash and futures positions. 

However, arbitrage funds are neither risk-free nor a guaranteed-return investment product. Returns depend on the availability of arbitrage opportunities, price spreads, transaction costs, liquidity, and execution. 

Thus, suitability depends on the investor's risk profile, investment horizon, and financial objectives.

An Investor Education and Awareness Initiative by Tata Mutual Fund. 

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