Avoid Income Plus Arbitrage Funds: A Risky Tax Gimmick

Thinking about Income Plus Arbitrage Funds? Know the pros and cons, hidden risks, and why pure arbitrage funds may still be the safer alternative.

In the fast-changing world of mutual funds, innovation often walks a fine line between genuine need and marketing gimmick. After the government removed indexation benefits from debt mutual funds in 2023, many fund houses scrambled to find new ways to retain investor interest.

Enter the so-called “Income Plus Arbitrage Funds” — a cleverly branded category that promises better returns than savings accounts, equity-like taxation, and low risk.

Sounds perfect? Not so fast.
Before you get lured into these shiny new wrappers, it’s crucial to understand the truth behind the marketing and why you should stay away from these gimmicks.

Avoid Income Plus Arbitrage Funds: A Risky Tax Gimmick

No SEBI Recognition, No Clear Regulations

First and most importantly:
There is NO SEBI-defined category called an “Income Plus Arbitrage Fund.”

These funds are just internally designed hybrids, combining:

• Arbitrage trades (buy stock in cash market, sell futures of the same stock), and
• Debt investments (corporate bonds, treasury bills, commercial papers).

Because SEBI doesn’t regulate them under a specific framework, the fund manager enjoys wide discretion:

• One month, the portfolio could be 70% arbitrage and 30% debt.
• The next month, it could flip to 40% arbitrage and 60% debt.
• Worse, debt quality could vary — from safe government securities to riskier corporate bonds.

As an investor, you’re entering a grey zone without even realizing it.
You have no assurance about how your money will be allocated — especially in volatile markets.

Designed to Exploit the Tax Loophole

The real reason these products exist is simple:
To offer equity taxation benefits to conservative investors who otherwise would have stayed in safe debt funds or fixed deposits.

Because these “Income Plus” funds invest a minimum 65% in equities (through arbitrage), they qualify as equity funds for taxation:

• Short-Term Capital Gains (STCG) taxed at 20%.
• Long-Term Capital Gains (LTCG) above Rs.1.25 lakh taxed at 12.5%.

Compare this to pure debt funds, where:

• Short-term or long term gains are taxed at your slab rate (up to 30%) irrespective of your holding period.

No wonder AMCs are aggressively marketing this — not for your benefit, but to keep their AUM (assets under management) growing.

Hidden Risks Lurking Inside

Despite being projected as a “safe” parking spot for idle cash, these funds carry serious hidden risks:

1. Credit Risk from the Debt Portion

This is a huge concern. Without a clear mandate, such funds can take unwanted credit risk. Hence, knowingly or unknowingly, you end up with a risky debt portfolio.

• Fund managers might invest in lower-rated corporate bonds to boost returns.
• If the company defaults or faces a downgrade, the fund’s NAV could take a sudden hit.
• Remember Franklin Templeton’s debt fund crisis? Investors learned the hard way that credit risk is real.

Let us take the example of few funds. Kotak Income Plus Arbitrage FoF portfolio is holding around 59% of its portfolio in Kotak Corporate Bond Fund Direct Growth. Same way, DSP Income Plus Arbitrage Fund of Fund is holding around 46.5% of its holdings in DSP Banking and PSU Debt Fund – Direct Plan – Growth. Also, Bandhan Income Plus Arbitrage Fund of Funds is holding around 61% in it’s Bandhan Corporate Bond Fund – Direct Growth. HDFC Income Plus Arbitrage Active FoF – Direct Plan is holding around 53% in HDFC Corporate Bond Fund.

If you blindly look into other funds also, it is the same story. Hence, you have to ask yourself of how much comfortable you are in taking such BLIND risk.

2. Interest Rate Risk

• If interest rates rise sharply, the value of the debt holdings can fall and vice verse. If your debt portfolio consists of long term bonds, then such volatility is huge.
• This can erode the portfolio value, especially in short-term timeframes.

3. Liquidity Risk

• During times of market panic (e.g., March 2020 COVID crash), arbitrage spreads dried up.
• This means the so-called “safe” arbitrage strategy generated almost no return for months.

4. Portfolio Transparency Issues

• Unlike pure arbitrage funds or regulated debt funds, these hybrids do not disclose detailed, fixed mandates for asset allocation.
• Investors are blindly trusting fund managers — without knowing how much risk they are taking at any given time.

5. Majority of these funds are old wine in new bottle

If you look into the age of these funds, you will notice that few are showing as 3+, 5+, or 10+ years old. But don’t go by this. They are earlier in a different avatar than what they are today. For example, DSP Income Plus Arbitrage Fund of Fund was earlier DSP Global Allocation Fund of Fund. Kotak Income Plus Arbitrage FOF was earlier Kotak All Weather Debt FOF. Same way, Bandhan Income Plus Arbitrage Fund of Funds was earlier Bandhan All Seasons Bond Fund. ICICI Prudential Income Plus Arbitrage Active FoF, earlier version was ICICI Prudential Income Optimizer Fund (FOF). HDFC Income Plus Arbitrage Active FOF, earlier version was HDFC Dynamic PE Ratio Fund of Funds. I am just highlighting the few. You can cross check on your own with other funds, also. The story will remain the same.

6. Never rely on past returns

As these funds are the new version of earlier debt funds, it is hard to assume that past returns will continue in future. Hence, never compare the returns to judge that these are superior than Arbitrage Funds.

Why Plain Arbitrage Funds Are Safer

If your goal is tax efficiency + safety, then pure arbitrage funds are a far better option.

• Pure arbitrage funds are regulated clearly by SEBI.
• They only focus on hedged positions in stock markets — buying in cash and selling in futures.
• They avoid the complexity and risk of holding unknown debt instruments.
• Returns typically range from 5% to 7% per annum — far better than savings accounts or liquid funds, with far lower risk.

No unnecessary gimmicks. No hidden exposure. No worrying about what the fund manager is cooking behind the scenes.

Simple is always safer.

Don’t Be a Scapegoat

Let’s call a spade a spade:
“Income Plus Arbitrage Funds” are cleverly disguised traps to catch unsuspecting investors who are chasing post-tax returns.

Fund houses know that after debt fund taxation changes, they could lose a huge chunk of AUM.
So instead of innovating responsibly, they invented a blurry, loosely structured product — one that:

• Looks safe,
• Feels familiar,
• But hides significant risk under the hood.

As an investor, you should never fall for such gimmicks. Your money deserves better — clarity, transparency, and simplicity.

The Wise Investor’s Approach

• If your goal is idle money parking,
• If you want to earn better than a savings account,
• If you want tax efficiency without hidden risk,

then the path is clear: Stick to pure arbitrage funds.

You don’t need an “income plus” gimmick to achieve your goals. You need discipline, not desperate innovation. However, beware that Arbitrage Funds may generate few months of negative returns during equity market volatility (Can Arbitrage Funds give negative returns?).

Final Word: Stay Simple, Stay Safe

Income Plus Arbitrage Funds are not solutions. They are products designed to benefit fund houses, not investors. At a time when financial marketing is getting increasingly sophisticated, it’s more important than ever to stay rooted in simple, clear investment principles. Don’t be a scapegoat. Don’t trade safety for gimmicks. Stick to pure Liquid Fund or arbitrage funds for your short-term requirements.