Surprise winner: Most popular fund category of May 2025

Think the most popular mutual fund category last month was small-cap, large-cap or multi-cap? Think again.

The top spot went to… arbitrage funds.

Yes, this fund category clocked Rs 15,702 crore in net inflows in May 2025. To add context, arbitrage funds’ net buying was almost five times more than small-cap funds last month, more than five times the net flows of multi-cap funds and over 12 times the net flows of large-cap funds, as per Association of Mutual Funds in India (AMFI) data.

Last month was not a one-off either. Arbitrage funds attracted over Rs 50,000 crore in the previous financial year (FY24–25).

So, given these funds have hit the mainstream, let’s find out how these funds make you money and whether there are other alternatives.

What are arbitrage funds?

As the name suggests, these funds aim to profit from price differences in different markets. For example, if a stock trades at Rs 100 on the NSE and Rs 105 on the BSE, the fund buys on one and sells on the other, pocketing the Rs 5 difference. Arbitrage can also occur between the cash and futures market, buying the stock in the spot market and selling a futures contract at a higher price.

Because of this strategy, arbitrage funds are far less volatile than regular equity funds. That’s why many investors use them as a relatively safer parking spot, especially for short-term needs or emergency money.

Reasons for growing popularity

Tax advantage: You pay 20 per cent on short-term gains and 12.5 per cent on long-term gains exceeding Rs 1.25 lakh annually. In contrast, gains from liquid funds, a fair comparison, are taxed as per your income slab. For someone in the highest slab, that’s a 30 per cent hit on gains.

Even with older debt fund investments (those bought before April 1, 2023), while the gains will be taxed at a flat 12.5 per cent, there’s no indexation benefit anymore — a change that makes arbitrage funds even more appealing.

Conducive market conditions: Arbitrage funds benefit from cash-future spreads. Spreads are the price difference between the cash price of a stock and the future market price. So, when the markets are in a positive zone, leverage positions increase, and so do the spreads. This allows an arbitrage fund manager to buy in the spot market and sell the future contract for a profit.

Is there another alternative?

Arbitrage funds are usually suitable for three months to a year.

However, liquid funds can often be a better fit for most investors with that time frame. They come with similar return potential but less volatility and greater safety.

In the past three and 12 months, the average arbitrage fund has returned 1.67 per cent and 6.71 per cent, respectively, slightly less than liquid funds’ 1.71 per cent and 6.93 per cent. But, despite the slightly better performance, liquid funds saw a whopping net outflow of over Rs 40,000 crore last month.

Our take

While returns wise, arbitrage funds and liquid funds are almost neck and neck, the latter have their noses in front in terms of stability and capital safety.

That said, arbitrage funds may appeal to those in the highest tax bracket, given the preferential tax treatment of these funds.

Also read: Top 5 mutual funds for a 10-year investment