Why are arbitrage funds attracting record investor money

Summary: Investors are rushing to arbitrage funds. We speak with Hiten Shah, manager of India’s largest arbitrage fund, to decode how these funds work, what’s powering the inflows and why they might deserve a spot in your portfolio. Get clarity on spreads, tax benefits and smart risk control. Arbitrage funds are having their moment. In just four months, the category has pulled in nearly Rs 50,000 crore—making it one of the hottest short-term parking spots for investors’ money. Steering the largest of the lot, the Rs 71,600-crore Kotak Arbitrage Fund, is Hiten Shah. With around 18 years of experience, the fund’s manager focuses on steady performance while swiftly acting on opportunities to lock in returns. In this conversation, Shah breaks down how arbitrage funds really work, what’s driving the recent surge in inflows and why they’re becoming a key diversifier in investor portfolios amid changing interest rate cycles. What exactly is an arbitrage fund, and how does it generate returns? It is based on the concept of the cost of carry. What does that mean? Suppose you're buying equity, you need to pay 100 per cent upfront. But if you're buying futures, then you only need to pay a margin to the exchange. Therefore, the funds left with the investor or the person buying futures can be deployed into other opportunities, such as other debt funds that offer returns. Essentially, arbitrage funds are based on the concept of the cost of carry. For example, let's say the cost of borrowing money for an investor buying futures is around 9 per cent. In that case, the price of the futures would usually be about 7-8 per cent higher than the cash (spot) price. Thus, the difference between the cash price and the futures price, while not always exact, generally reflects the cost of carry in the short term, which is the cost of holding that position until expiry. Simply put, the arbitrage category has followed short-term interest rates over the last 10 to 15 years. When interest rates were higher, around 8–9 per cent about 15 years ago, the arbitrage category also yielded returns of aro