Arbitrage Funds After STT Hike: What Mutual Fund Investors Need to Recalculate

If you use arbitrage mutual funds to park short-term surplus money, Budget 2026 quietly changes the math.

The product is the same. The tax rules are the same. But one cost inside the strategy went up. And arbitrage is a thin-margin strategy, so small cost changes matter.

So the right question is not “Are arbitrage funds bad now?” The right question is “Will they still beat liquid and short-duration debt funds for my holding period, after costs?”

What Are Arbitrage Funds

Arbitrage funds try to capture small price gaps between the cash market (spot) and the futures market.

A common setup is simple. The fund buys a stock in the spot market and sells the same stock’s futures contract. The gap between spot and futures, after costs, becomes the return opportunity.

People use arbitrage funds because they usually show low volatility, they get equity-style taxation, and they work as a parking tool when you do not want equity-like ups and downs.

What changed in Budget 2026

Budget 2026 increased STT on futures from 0.02% to 0.05%.

This matters because arbitrage funds use futures trades heavily. Higher STT means higher transaction costs for the fund manager. Those costs come directly out of the spread the fund is trying to earn.

Nothing breaks in the strategy. But the profit window becomes narrower.

How the STT Hike Affects Arbitrage Funds

Think of arbitrage returns like this:

The spread is not big most of the time. That is why arbitrage is usually low risk and modest return.

When a cost like STT rises, net spreads shrink and very short holding periods feel it more because you have less time for returns to build up.

Arbitrage is like a high-volume business with thin margins. Even a small cost hike can reduce the final outcome.

What happens to your returns now

Expectations need a reset.

Earlier, arbitrage funds often delivered returns similar to liquid funds, and sometimes looked better post-tax because of equity taxation.

Now, after the STT hike:

• Gross returns may dip because costs have gone up.
• The gap vs liquid funds may shrink, especially in calmer markets where spreads are already tight.
• Short holding periods may feel it more because the cost impact is more visible.

Arbitrage opportunities are typically better when spreads are healthy. In dull market phases, spreads are tighter, and higher costs pinch more.

Arbitrage funds vs liquid funds vs ultra-short debt: how to choose now

A simple way to think about these options is to match the product to your bucket and time horizon.

After the STT hike, the decision is less about labels and more about your holding period and tax bracket. If you park money for very short periods, a liquid fund can still be hard to beat on simplicity. If you park money for longer and you are in a higher tax bracket, arbitrage may still work, but expect modest outcomes.

Tax angle: still equity-like, but do not ignore pre-tax returns

Arbitrage funds continue to be taxed as equity funds.

• STCG: taxed at 20%
• LTCG: above ₹1.25 lakh in a financial year taxed at 12.5%

This equity-style taxation is a key reason many investors use arbitrage funds instead of debt funds for parking money.

But one point matters most. Tax efficiency helps only if the pre-tax return remains meaningful. If higher costs reduce the return gap too much, the equity tax benefit alone will not make arbitrage the best option for every investor and every time frame.

When arbitrage funds still make sense

• You want low volatility and you are okay with modest returns.
• You are in a higher tax bracket and prefer equity-style taxation for parked money.
• You are parking money for weeks to a few months, not for a few days.
• You treat arbitrage as a parking tool, not a return-chasing product.

When you should rethink using them as a default

• You park money for very short periods and you want highly predictable outcomes.
• You expect arbitrage to always beat liquid funds regardless of spreads and costs.
• You are choosing based only on past returns.
• You are using it as an emergency bucket without rechecking access and timing needs.

What you should recalculate before you decide

Arbitrage funds have not stopped working. But they are no longer a no-brainer default for every surplus cash situation.

Takeaway

Arbitrage funds are not broken. The easy default idea is.

The STT hike reduces the strategy’s net efficiency, so returns can look a bit lower and closer to liquid funds, especially for short holding periods. If you are using arbitrage purely for short-term parking, revisit the comparison and reset expectations.

FAQs

Will arbitrage funds stop being tax-efficient after the STT hike?

No. The tax classification remains equity-like. The change is on the cost side, which can reduce pre-tax returns.

Will arbitrage funds become risky now?

The STT hike does not directly increase risk. It mainly reduces net returns because spreads are typically thin.

Are liquid funds better now?

For very short parking periods, liquid funds can look more attractive because their return drivers are simpler. For longer parking, arbitrage may still be relevant, but the edge may be smaller.

What holding period makes arbitrage worth it?

There is no fixed number. In practice, it tends to make more sense when you are parking money for weeks to a few months and you value equity-like taxation.

Do all arbitrage funds get impacted equally?

No. It depends on trading efficiency, expenses, and how actively the fund runs the strategy.

Does higher volatility help or hurt arbitrage returns?

Arbitrage depends more on spreads than volatility. Market phases that widen spot–futures spreads can improve opportunities.

Can I use arbitrage funds as an emergency fund?

If you need quick access and high predictability, compare liquid and overnight options too. Emergency buckets are about access first, returns second.

What is the simplest way to decide between arbitrage and liquid funds now?

Start with your holding period and tax bracket, then compare recent net returns after expenses. If the gap is small, pick the option that matches your need for predictability.

Disclaimer: This article is for information and educational purposes only and should not be treated as investment or tax advice. Mutual fund investments are subject to market risks. Read all scheme related documents carefully before investing.

Disclaimer: This article is for general information and educational purposes only. It does not constitute investment advice, a recommendation, or an offer to buy or sell any securities. Any references to companies or financial figures are for discussion and understanding of business models and reported results. Please consider consulting a qualified professional before taking any financial decision.