It’s the hybrid era. Everything from cars to work models seems to be going hybrid. So, why not hybrid funds? One investment vehicle under the hybrid category that has gained immense popularity is arbitrage funds, as they invest in both debt and equity. But what is the meaning of arbitrage funds and what are the best arbitrage funds in India? Let’s find out.Arbitrage Fund MeaningAn arbitrage fund is suitable for investors who seek potential returns from market volatility. Essentially, an arbitrage mutual fund takes advantage of the difference in the price of a security in the spot and the futures markets.For example, if the outlook of a security is bearish, an arbitrage fund sells shares of that company in the cash market, while simultaneously purchasing low-priced futures contracts of that security. If the outlook of a security is bullish, an arbitrage fund purchases that security in the cash market and simultaneously sells high-priced futures contracts of that security.The difference in price of the security in the cash market and the futures market will be the profit of the arbitrage fund. Usually, this difference is minute. However, arbitrage funds aim to make a decent profit by trading high volumes.  Benefits of Arbitrage FundsThe primary benefit of investing in an arbitrage fund is that it involves lower risk than equity mutual funds. Since securities are bought and sold simultaneously, the fund doesn’t have to bear the risk of longer-term price variations.Further, an arbitrage fund may invest a portion of its capital into debt securities, which are safer than equity securities. This is because sometimes there is a lack of arbitrage in the markets during periods of low volatility. In such situations, arbitrage funds still keep their funds invested, so that they can earn some returns.Arbitrage funds are most suitable for more cautious investors. These investors can aim to profit from volatility arbitrage without the risks involved in stock trading.You could also consider investing in open-ended arbitrage funds, as these allow you to redeem the fund units any time you want.How are Arbitrage Funds Taxed in India?Arbitrage funds are categorised as equity mutual funds for tax purposes. This is because, on an average, the majority of the investment of such funds are in equities.The effective tax rate on your gains from such an investment depends on the length of your holding. If you invest in such a fund for less than a year, your gains are taxed as “short-term capital gains” at a rate of 15%.However, if you hold your investment for more than a year, your gains are classified as “long-term capital gains”. This means that any gains below Rs. 1 lakh are not taxed. Any gains above Rs. 1 lakh are taxed at a rate of 10%.Wrapping UpArbitrage fund returns are tax efficient, which makes them an attractive investment choice. You can even invest in them in the form of an SIP. A Systematic Investment Plan, or SIP, is a facility whereby you can invest a small amount of money at regular intervals. For instance, you can invest Rs.500 monthly. It is a good idea to read the documents carefully before investing in arbitrage funds, so that you understand the potential risk-reward trade-off.

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