Not every investment is about the long term. Sometimes, you’re simply preparing for something just a few years down the road. Maybe in 1 year, maybe in 3. In those cases, you want a fund that’s safe, quick to access, and gives better returns in a short-term period.
Two popular options in 2025 are arbitrage funds and liquid funds. In fact, in May alone, arbitrage funds pulled in ₹15,702 crore outpacing all other mutual fund categories. This blog helps you understand how these short-term options work and what you should know before choosing one.
What are arbitrage funds?
Arbitrage funds are a type of hybrid mutual fund that invest at least 65% in equities but don’t carry the same risk as regular equity funds. They aim to earn from price differences in the cash and futures markets. The remaining part is parked in debt or money market instruments to add stability.
If held for over a year, they’re taxed like equity, long-term gains above ₹1.25 lakh are taxed at 12.5%. Withdrawals follow the T+2 redemption cycle, meaning funds are credited to your bank account within two working days after the redemption request is processed.
What are liquid funds?
Liquid funds fall under the debt mutual fund category and invest in money market instruments with maturities up to 91 days, like treasury bills and commercial papers. These funds don’t swing much with market changes and are designed to keep your money safe and accessible.
Most redemptions are processed within one working day, and some even offer instant withdrawals up to a limit. Returns from liquid funds are taxed as per your income slab if held for less than three years.
The structure and simplicity of liquid funds make them useful for situations where funds need to remain safe, accessible, and available for short-term use.
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Key differences: Arbitrage funds vs liquid funds
Now that we’ve looked at how arbitrage and liquid funds work individually, here’s a side-by-side comparison to help you decide which one suits your needs better.
| Feature | Arbitrage funds | Liquid funds |
| Fund type | Hybrid fund (mix of equity and debt) | Debt fund |
| Where they invest | Mostly in equity (65%) and rest in debt/money market instruments | Short-term debt like treasury bills, commercial papers |
| Maturity/duration | No fixed maturity. | Invests in papers with upto 91-day maturity |
| Redemption timeline | 2–3 working days (T+2 payout) | Within 1 working day |
| Risk level | Low to moderate; may vary slightly with market spreads | Very low; stable and low chance of loss |
| Tax rules | Treated as equity fund (LTCG: 12.5% after 1 year, STCG: as per slab) | Treated as debt fund (taxed as per slab rate) |
| Return pattern | May vary slightly, better in volatile markets | More steady and predictable |
| Average returns (as of June 2025) | 1-year return: 7.67% 3-year returns: 7.6% | 1-year return: 6.94% 3-year returns: 6.4% |
Also read: Mutual Fund vs PMS vs AIF: Key Differences
Recent regulatory and market updates 2025
If you are weighing arbitrage funds vs liquid funds for short-term investing in 2025, SEBI’s latest rules are crucial to your decision:
- Liquid funds accepted as regulatory deposits
SEBI now allows investment advisers and research analysts to use liquid and overnight funds as regulatory deposits, not just bank FDs. This rule is based on the safety and liquidity of these funds and must be followed by June 30, 2025.
The deposit value is based on the NAV after exit load, and more units must be added if the value drops. This move shows SEBI’s trust in liquid funds for short-term, low-risk needs.
- SEBI’s new F&O rules (May 2025)
SEBI has introduced stricter rules for the equity derivatives (F&O) market to curb speculation and enhance market stability. Key changes include improved position limits for index options (up to ₹10,000 crore gross), new methods for measuring open interest, linking market-wide position limits (MWPL) to free float and cash volumes, and more frequent intraday monitoring of limits.
For arbitrage funds, which depend on F&O trades to generate returns, these rules may reduce available arbitrage opportunities and could lead to more stable but potentially lower returns for short-term investors
- SEBI recategorisation and scheme alignment
SEBI’s recent directives aim to simplify scheme categories and their names, ensuring they truly reflect investment strategies for easier investor understanding. This builds on previous efforts to make funds “true to label,” improving transparency and comparison across the industry. For instance, changing “Bluechip Fund” to “Large Cap Fund.”
Also read: SEBI’s AI Adoption and Its Impact on Market Regulation
What’s better for short-term investment in 2025?
Choosing between arbitrage and liquid funds depends on your short-term financial needs and risk tolerance:
Choose arbitrage Funds If:
- You can handle slight volatility: They exploit cash-futures spreads, which can vary with market conditions.
- You’re okay with a 2-3 day redemption window: Settlements follow the T+2 cycle, typically completing in 2–3 days .
Choose liquid Funds If:
- Same-day access matters to you: SEBI’s updated rules let you redeem liquid funds and receive NAV-based redemption by the next business day.
- Minimal volatility is your priority: These funds invest in short-duration instruments (less than 91 days) and remain largely unaffected by market shifts.
Conclusion
Arbitrage funds vs liquid funds, both serve well for short-term investing but with different strengths. Want better post-tax returns and flexibility? Arbitrage returns can be a suitable option to look for. Want low risk? Liquid funds can be considered. It’s not about which is better, it’s about what fits you best. Just pick the one that matches how you like to invest.
FAQs
An arbitrage fund is a type of hybrid mutual fund that seeks to generate returns by exploiting price differences between the cash (spot) and derivatives (futures) markets. The fund manager simultaneously buys securities in one market and sells in another to lock in risk-free profits. These funds are classified as equity-oriented because they invest at least 65% in equities, but their risk profile is closer to debt funds due to the hedged strategy.
Arbitrage funds and fixed deposits (FDs) serve different needs. Arbitrage funds may offer better post-tax returns for some investors and are considered low risk, but returns are not fixed or guaranteed. FDs provide assured returns and principal protection but may be less tax-efficient for those in higher tax brackets. The suitability depends on your risk tolerance and investment goals.
Liquid funds are debt mutual funds investing in short-term instruments (treasury bills, commercial papers) with maturities under 91 days. They offer very low volatility and liquidity. On the other hand, arbitrage funds are hybrid schemes with at least 65% in equities, using price-difference opportunities between cash and futures markets, plus debt backing. They are taxed as equity. Essentially, liquid funds focus on capital preservation and instant access, while arbitrage funds aim for modest market-linked returns.
Liquid funds are considered relatively safe among mutual fund categories, but they are not 100% risk-free. They primarily invest in short-term money market instruments, aiming for high liquidity and capital preservation. While risks like credit risk (issuer default) and interest rate risk (market rate fluctuations) exist, they are generally minimal due to the short maturity and high credit quality of instruments. SEBI regulations also mandate maintaining a portion in highly liquid assets to meet redemptions.
No, SIP is not a liquid fund. SIP (Systematic Investment Plan) is a method of investing a fixed amount regularly into a mutual fund scheme. Whereas, liquid funds are a type of mutual fund that primarily invest in highly liquid money market instruments with maturities generally up to 91 days. While you can choose to invest in a liquid fund through an SIP, the SIP itself is merely the investment approach, not the underlying fund category.
