Tax-efficient 'income plus arbitrage' mutual funds are seeing a reversal in fortunes, shifting from strong 2025 inflows to net outflows this year. Investors are pulling back due to complex fund structures, concerns over double-layer expense ratios, and performance that has frequently lagged behind simpler, traditional debt investment options.
Mutual funds designed to combine debt income with arbitrage strategies are facing a significant shift in investor interest. After a period of high popularity that brought in approximately ₹21,000 crore in 2025, the category has seen investors withdraw about ₹2,000 crore through July 31, 2026. This change in sentiment highlights the growing hesitation among retail and high-net-worth investors to park capital in these relatively new and complex products.
The core appeal of these funds has always been their potential for tax efficiency. By splitting investments between debt instruments and arbitrage—which exploits price differences in the cash and futures markets—these schemes aim to qualify for capital gains tax treatment similar to equity. This means that if held for at least 24 months, gains are taxed at 12.5%, which is significantly lower than the standard tax rate for interest earned from traditional debt funds.
However, the strategy comes with operational complexities that investors are increasingly noticing. Many of these schemes are structured as 'Fund of Funds' (FoF). This means the fund invests in other underlying schemes, leading to two levels of management fees—one at the fund level and another at the underlying scheme level. This 'double-layer' of costs can eat into the final returns, making it harder for the fund to beat simpler, lower-cost alternatives like money market or corporate debt funds.
Performance data has also played a role in the cooling interest. In the past year, the category has reported average returns of approximately 5.7% to 6.0%, which has often lagged behind the returns of simpler money market funds and short-duration debt funds. When investors compare the risk-adjusted returns of these hybrid products against traditional fixed-income options, the added complexity often outweighs the tax benefits, especially if the investor does not maintain the two-year holding period required to actually receive the tax advantage.
Major asset managers, including HDFC Mutual Fund and Sundaram Mutual Fund, have introduced offerings in this space, with the total number of such schemes reaching 22. Despite the scale of these launches, the lack of standardized definitions for terms like 'active' or 'omni' in these funds has created confusion. For the average investor, it is often difficult to understand exactly where their money is going, as the underlying strategy can involve everything from government bonds to corporate debt.
Moving forward, the primary monitorable for investors will be whether these funds can deliver consistent performance that justifies their expense ratios. Those considering these products may need to carefully evaluate their own investment horizon. Because the tax benefits are tied to a 24-month holding period, these funds are generally not suitable for short-term parking of money. As the category matures, investors may watch for potential changes in fee structures or clearer communication from fund houses regarding the underlying strategies.