As an investor, what are the two things you expect from your portfolio? In an environment where stability and consistent income are in high demand, investors are increasingly looking at blended strategies offering the best of multiple asset classes. A fund-of-funds (FOF) structure combining debt and arbitrage-based investments merges the steady nature of fixed income instruments with the return-enhancing potential of arbitrage. Here is what you need to know.
Diversification – a key to managing market uncertainty
One of the core strengths of this strategy lies in its diversified exposure. Typically, up to 65 percent of the portfolio is allocated to debt schemes and money market instruments, which provide stable returns through accrual income and professional duration management. The remainder channels into arbitrage schemes that capture short-term price differences in the equity market, offering return potential with lower volatility than traditional equity strategies. Combined, they cushion against market fluctuations while aiming for steady, risk-adjusted results. These instruments provide relatively stable returns through accrual income while professional managers implement duration strategies effectively. By combining multiple exposures within one fund, investors reduce single-asset risk and enjoy a smoother performance profile.
1 July 2025
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Tax efficiency – a distinct advantage
A major attraction of the debt-arbitrage FOF is its favourable tax treatment. Under current Indian regulations, switching between debt schemes incurs tax at the investor’s slab rate. Within an FOF, these switches do not trigger capital gains tax; investors are taxed only on redemption. If held for more than 24 months, gains qualify as long-term capital gains and are taxed at a concessional rate of around 12.5 percent (including surcharge and cess). This is a significant benefit for investors in higher tax brackets, who otherwise face substantially higher slab-based taxes. Moreover, intra-fund reallocations remain tax-deferred until redemption, unlike direct scheme switches, offering additional flexibility.
Professional management and tactical allocation
This blended strategy enables fund managers to dynamically allocate between debt and arbitrage based on prevailing market conditions. Debt portfolios are actively positioned to capitalise on interest-rate movements, while arbitrage allocations adjust according to market spreads and liquidity. Managers also benefit from scale efficiencies and reduced transaction costs compared to standalone arbitrage funds. This approach suits investors seeking a hands-off journey without the need to track macroeconomic trends or time market entry and exit. Think of it as test cricket — patience and discipline in selecting favourable risk-return opportunities.
Who should consider this strategy?
This approach is ideal for investors seeking:
Regular income from relatively low-risk instruments
Tax-efficient solutions over a medium-term horizon
A simplified investment experience without active monitoring
Exposure to both debt and equity via arbitrage, with reduced volatility
Whether you are planning short-term savings or complementing a broader portfolio with a conservative core, this blend of debt and arbitrage may offer a balanced solution.
A compelling case for volatile markets
In summary, a blended debt-arbitrage FOF structure offers Indian investors an all-in-one vehicle for income generation and capital preservation. It provides diversification across asset classes, professional management, and significant tax advantages. In an increasingly complex financial landscape, such strategies can serve as a prudent middle ground for conservative investors seeking growth with peace of mind. It’s always advisable to consult a financial or tax advisor to ensure alignment with personal goals and risk tolerance. It can form the conservative core of a broader portfolio, offering stability amid market swings. It’s a compelling alternative.
Disclaimer: The Views are Personal and not a part of the Outlook Money Editorial Feature
