Widely read:
AI-generated image
A brand-new mutual fund category is quickly gaining popularity. Several fund houses - Bandhan, AxisAditya Birla,Kotak, HDFC and DSP—have repackaged existing schemes or launched new ones under the new income plus arbitrage format.
As investor interest builds, one question keeps coming up: What are these funds, how do they work, and can they replace traditional debt funds?
What are income plus arbitrage funds?
These are fund of funds (FoFs) that invest in arbitrage funds and debt funds. The key objective is simple: Deliver debt-like stability with lower taxation.
They emerged in response to tax changes.
The 2023 Budget made debt funds less attractive by making their gains taxable at the investor's slab rate. This means that if you are in the highest tax slab, you'd have to cough out a 30 per cent tax on debt fund gains.
However, the very next year, FoFs received a boost. From their gains being taxed at the slab rate, the government gave them a sweet deal: Hold them for over two years, and you're taxed at just 12.5 per cent as long-term capital gains. The only catch is that these FoFs shouldn't hold more than 65 per cent in debt instruments.
So, to take advantage of this, fund houses began launching new FoFs or restructuring their existing funds and ensured they stayed below the 65 per cent debt cap by adding arbitrage exposure.
Naturally, fund houses saw an opportunity. They quickly launched new FoFs or restructured old ones—this time with a mix of debt and arbitrage—to stay under that 65 per cent debt limit.
And just like that, a brand-new, tax-friendly category was born.
For example, on a Rs 1 lakh gain:
- A traditional debt fund (taxed at the highest 30 per cent rate) would cost you Rs 30,000 in tax.
- An income plus arbitrage fund> (taxed at 12.5 per cent) would cost just Rs 12,500.
That's a 60 per cent tax saving.
What about returns and risk?
Let's look at the performance first. The average one-year returns, rolled on a daily basis over the last five years, for arbitrage funds are around 5.6 per cent, while short-duration debt funds have delivered 6.8 per cent.
Regarding risk, the worst one-month return for arbitrage funds over the last five years was -0.22 per cent, with less than 0.5 per cent of the time turning negative. This indicates that arbitrage funds may lag slightly in returns, but continue to offer downside protection and steady performance.
However, since these are fund of funds (FoFs), you end up paying two sets of fees—one for this fund, and one for the funds it invests in—which can eat into your final returns.
Can they replace traditional debt funds?
That's still too early to say.
Yes, the tax benefit is compelling, especially for investors in higher slabs with a long enough holding period.
However, income plus arbitrage funds are a new category, and there are just 12 of them in the market. Many of them have only just been launched or restructured. There isn't enough track record yet to judge how they will perform across market cycles, how stable their arbitrage opportunities will remain or how efficiently they'll manage costs.
And since these are FoFs, it also means their expense ratios are likely to be higher. If costs stay high, they could eat into the modest returns these funds typically generate.
Hence, it's best to approach them as a satellite allocation—a potentially tax-efficient add-on—rather than the foundation of your fixed-income strategy. At least for now.
Also read: The range of debt funds
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
For grievances: [email protected]
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
