Arbitrage funds vs STT hike: What mutual fund investors need to recalculate

Investors seeking comparatively consistent, tax-efficient profits with little market risk have long favoured arbitrage mutual funds. The Securities Transaction Tax (STT) hike announced in Budget 2026, however, is expected to alter the situation somewhat.

Even if these funds won't immediately lose their appeal, raising trading costs could reduce the small profits that make arbitrage methods attractive. This would lead investors to scrutinise their portfolios more closely.

Before reading further, please note that this is just for informational purposes only and not intended to recommend any of the schemes mentioned below.

Experts warn that the recent STT hike could slightly dent the returns from arbitrage funds, prompting investors to reassess their short-term investment choices.

"STT hike will lead to a reduction in approximately 0.25% to 0.30% annualised returns of Arbitrage Funds from the next fiscal. So, investors will have to check their post-tax ROIs after accounting for this drop in Arbitrage Fund returns and then compare it versus Liquid / Ultra Short Term Funds for temporary parking of their funds," said Ronak Morjaria, Partner at ValueCurve Financial Services.

What Budget 2026 proposed for STT

• Balanced Advantage Funds (BAF)

• Equity Savings Funds

For BAFs and Equity Savings Funds, the impact is only on the derivative portion used for hedging, so overall returns may dip marginally.

How the STT hike affects returns

"Arbitrage funds generate returns by exploiting price differentials between the cash and futures markets. A higher STT increases transaction costs and therefore compresses the net arbitrage spread, leading to a marginal reduction in returns. However, since arbitrage strategies operate with low volatility and market spreads tend to adjust over time, the overall impact on absolute returns is expected to be limited, as fund managers factor these statutory costs into their trade execution," said Pankaj Mathpal, MD & CEO at Optima Money Managers.

The recent STT hike will slightly reduce the annualised returns of arbitrage funds. Investors should review post-tax returns and consider alternative short-term options if needed, while keeping in mind that arbitrage funds remain a relatively low-volatility, tax-efficient investment choice.

How Arbitrage funds are taxed

Arbitrage funds have become increasingly popular among investors primarily due to their tax efficiency. The gains from arbitrage funds are taxed similarly to equity investments:

• Short-term capital gains (STCG): If the investment is held for less than 12 months, the profits are taxed at 20%.
• Long-term capital gains (LTCG): If the investment is held for more than 12 months, the gains above ₹1.25 lakh are taxed at 12.5%.