What Is Arbitrage PMS? Market-Neutral Returns and Tax Explained

Most portfolio management services sell one idea: a manager picks stocks that will beat the market. An arbitrage PMS sells the opposite idea. It tries to make money while having almost no view on where the market goes.

The manager buys a share in the cash market and, at the same moment, sells a futures contract on the same share for a slightly higher price. When the contract expires, the two prices meet. The difference locked in on day one, less costs, is the return. If the market falls 10% in between, the shares lose and the short futures gain by almost the same amount. If it rises, the reverse happens. That is what market-neutral means here: the position is hedged, so the market's direction largely cancels out.

Because the gap between cash and futures prices reflects the cost of financing a share until expiry, an arbitrage strategy earns something close to a short-term interest rate. That makes it a cousin of a liquid fund or a fixed deposit, not of an equity portfolio. Estee Advisors, which runs one of the oldest arbitrage PMS strategies in India, positions its product as a treasury or fixed-income alternative rather than an equity product.

So why use a PMS when arbitrage mutual funds already hold nearly Rs 3 lakh crore? The answer lies in structure, tax and control, and the trade-offs are sharper than most marketing material admits.

Cash-futures arbitrage needs a futures market. India's began on 12 June 2000, when NSE launched index futures on the Nifty 50. Futures on individual shares followed on 9 November 2001. Securities transaction tax (STT) arrived with the Finance (No. 2) Act, 2004, and it has shaped arbitrage economics ever since, because the trade earns a thin margin on large turnover.

SEBI's circular of 6 October 2017 on the categorisation of mutual fund schemes created an Arbitrage Fund category: a "scheme following arbitrage strategy" with at least 65% in equity and equity-related instruments. That equity floor matters for tax, as we will see.

PMS managers were already running arbitrage mandates. Aggregator data lists Globe Capital's arbitrage strategy with an inception of 14 January 2008 and Estee's I-Alpha with 1 October 2009.

A PMS can use derivatives, within limits. The SEBI (Portfolio Managers) Regulations, 2020 forbid a manager to leverage a client's portfolio for investment in derivatives. SEBI's Master Circular for Portfolio Managers of 16 July 2025 permits derivatives, including for hedging and portfolio rebalancing, through recognised exchanges. The client agreement must spell out the type, purpose and quantum of derivative exposure, and total derivatives exposure should not exceed the funds placed with the manager: the manager should "invest and not borrow" for the client.

That framework is changing. The SEBI (Portfolio Managers) Regulations, 2026 were notified on 7 October 2026 and take effect on 1 April 2027; until then the 2020 Regulations and the 2025 Master Circular apply. The new regulations allow exchange-traded derivatives within limits SEBI will specify, and the SEBI Board approved flexibility of up to 1.25 times a client's AUM. The detailed circular had not been issued at the time of writing.

In a PMS, nothing is pooled. The shares are bought into your demat account and the futures are sold in your derivatives account through the manager's broker, and each trade appears on your statements. An arbitrage PMS therefore runs the same cash-futures arbitrage as a mutual fund, but the positions belong to you.

• Cash leg: buy the share for delivery at today's price.
• Futures leg: sell the same quantity through the near-month futures contract, normally at a higher price.

The gap between futures and spot is the basis. Futures usually trade above spot, because a futures buyer avoids paying for the shares today and should compensate the seller for that financing cost. As expiry approaches, the basis shrinks towards zero, and on expiry day the two prices converge.

Take a share at Rs 1,000 in the cash market, with a future 30 days from expiry at Rs 1,006. The manager buys 1,000 shares for Rs 10 lakh and sells futures on 1,000 shares at Rs 1,006.

• Locked-in gross spread: Rs 6,000, or 0.60% for the month, about 7.3% annualised on a simple basis.
• If the share ends at Rs 1,100, the shares gain Rs 1,00,000 and the futures lose Rs 94,000. Net: Rs 6,000.
• If the share ends at Rs 900, the shares lose Rs 1,00,000 and the futures gain Rs 1,06,000. Net: Rs 6,000.

Since 1 April 2026, STT is 0.1% on a delivery purchase, 0.1% on a delivery sale and 0.05% on the sale of a future. If the whole position is opened and closed within the month:

STT alone takes about 42% of the gross spread in a one-month round trip, before brokerage, exchange charges, stamp duty, GST and the PMS fee. The net falls from 0.60% to about 0.35%.

That is why arbitrage desks usually keep the shares and roll the hedge: buy back the expiring future and sell the next month's. STT applies to the sale of a future, so each roll costs about 0.05%, while the 0.2% of delivery STT is paid only when the shares are first bought and finally sold. Held for a year, that works out to under 0.02% a month. The figures are illustrative; real spreads change daily.

Managers do not always wait for expiry. If the basis narrows sharply mid-month, closing both legs early captures most of the spread and frees the capital. Estee says its I-Alpha strategy exits once spreads narrow enough.

Not every arbitrage strategy has a cash leg. Estee describes trading index derivatives against a basket of single-stock derivatives weighted like the index, with roughly 99% of capital in fixed deposits and a small portion used as margin collateral. In that design both legs are derivatives, which matters for tax. Other variations include put-call parity trades and event-driven trades around mergers; the last carries deal risk, because a merger can collapse.

The basis exists because holding shares ties up money. The cost of carry model says a fair futures price equals the spot price plus the interest cost of holding the share until expiry, less any dividends received. If futures trade well above that level, arbitrageurs buy cash and sell futures until the gap closes.

In practice supply and demand set the basis, but it gravitates towards the cost of money, so returns from an arbitrage fund or arbitrage PMS move with short-term rates. PrimeInvestor identifies three main drivers of spreads:

• Short-term interest rates, which set the base level.
• Futures traders' risk appetite: keen leveraged buyers bid futures up and widen spreads, so opportunities are more plentiful in bullish markets.
• Large participants entering or exiting, such as foreign portfolio investors, who can move spreads quickly.

Rates are now rising. On 7 October 2026 the RBI's Monetary Policy Committee voted unanimously to raise the repo rate by 25 basis points to 5.50% and changed its stance to "calibrated tightening". Higher funding costs should support wider spreads, but trader appetite also matters, so a rate rise does not pass through one for one.

The rate link also sets the ceiling. An arbitrage strategy will not deliver equity-like returns. Its job is to beat a deposit rate after costs and tax, with low volatility.

Arbitrage is a thin-margin business, so every cost layer matters.

The Union Budget 2026-27 memorandum proposed raising STT on the sale of a future from 0.02% to 0.05%, saying it would address a "disproportionate increase in speculation in futures and options trading". The Finance Act, 2026 received assent on 30 March 2026, and NSE applied the new rates from 1 April 2026. For a strategy that rolls futures monthly, that is an extra 0.03% a month, or about 0.36% a year on the hedged amount.

Margin is the hidden cost. Losses on short futures are settled in cash every day, even when the matching shares have gained by the same amount, so the manager must keep cash or approved collateral ready. Because PMS derivatives exposure should not exceed the client's funds, nothing can be borrowed to meet those calls.

Fees can decide the outcome. Business Today's listing of Globe Capital's arbitrage strategy shows a 2.5% fixed fee, a 10% hurdle for profit sharing, exit loads of 3%, 2% and 1% over three years, and the Rs 50 lakh minimum. A 2.5% fee on a strategy whose economics sit near the repo rate absorbs a large share of the return. Estee mentions structured fee models without publishing figures. Get the full fee schedule in writing; SEBI requires reported PMS performance to be net of all fees and expenses.

Arbitrage PMS is a niche. We queried the Association of Portfolio Managers in India (APMI) performance database for all four strategy types as on 30 September 2026. The equity list alone covered 1,228 discretionary investment approaches. Only a handful involve arbitrage:

Returns are time-weighted, annualised beyond one year and net of fees and expenses, but before the investor's own tax. At the margins sit an Edelweiss "Event Arbitrage" approach with Rs 0.31 crore, an NJ non-discretionary portfolio of arbitrage schemes (Rs 74.03 crore) and a small Capitalmind non-discretionary "debt and arbitrage" mutual fund portfolio. Those are event trades or fund portfolios, not direct cash-futures arbitrage.

The pure strategies together manage a few hundred crore rupees. Arbitrage mutual funds had 40 schemes and Rs 2,97,632 crore at the end of September 2026, according to AMFI's monthly report, even after a net outflow of Rs 3,956 crore that month. Investors in this strategy overwhelmingly choose the fund wrapper.

The label is not the strategy. Globe's approach adds long-term stocks and special situations to arbitrage, and its six-month return of 28.23% and one-month return of -2.83% are not what a market-neutral book looks like. Read the investment approach, not the name.

SEBI's benchmarking framework tags every PMS investment approach as Equity, Debt, Hybrid or Multi Asset. There is no arbitrage tag. Equity benchmarks are broad indices such as the NIFTY 500 or BSE 500, and arbitrage indices appear only inside hybrid and multi-asset composites.

The result is mismatch. AltPort lists the dezerv arbitrage strategy against the BSE 500 TRI, which returned 12.09% a year over three years to August 2026 against the strategy's 7.14%. Estee's I-Alpha sits in the debt bucket against a bond index. Neither comparison shows whether the manager is good at arbitrage. Compare instead with arbitrage funds, liquid funds and deposit rates over the same period, after costs and tax.

The same trades produce very different after-tax results depending on the wrapper.

An arbitrage mutual fund qualifies as an equity-oriented fund if at least 65% of its proceeds are invested in equity shares of listed domestic companies, measured as an annual average of monthly averages. Under the Income-tax Act, 2025, which replaced the 1961 Act from 1 April 2026, that definition sits in section 198 (old section 112A). The hedged share positions count towards the 65%, which is why a rate-like product gets equity taxation.

The investor pays tax only on redemption:

• Units held up to 12 months: short-term capital gain at 20% under section 196 (old 111A).
• Units held over 12 months: long-term capital gain at 12.5% above Rs 1.25 lakh a year under section 198 (old 112A).
• Surcharge on these gains is capped at 15%, so the top short-term rate is about 23.92% including cess.

Check that the scheme actually meets the test; do not rely on its category name alone.

In a PMS, each leg is taxed as if you had traded it yourself, in the year it happens.

The futures leg. Profits on exchange-traded derivatives are excluded from the definition of a speculative transaction, so they are non-speculative business income at your slab rate. Under the 2025 Act, this carve-out (old section 43(5)(d)) sits in section 66, according to tax commentators. At the top slab that is about 39% under the new regime, or about 42.74% under the old regime, including surcharge and cess. Estee's managers say trading gains in their strategy are treated as business income.

The cash leg. This is where treatment is disputed:

• As capital gains. The investor treats the shares as investments, and gains are short-term capital gains at 20% under section 196, since STT is paid. A 2016 CBDT circular accepted that listed shares held over 12 months may be treated as capital assets if the taxpayer is consistent, but arbitrage holdings are far shorter, and the circular predates the new Act.
• As business income. The cash leg can be seen as part of one trading operation aimed at the spread. In Radials International v ACIT (2014), the Delhi High Court said a PMS agreement is only an agency and that PMS gains must be judged on the frequency, volume and holding period of the trades. It found capital gains there because about 71% of the shares had been held for more than six months. An arbitrage book held for weeks sits at the other end of that test.

We found no ruling on a PMS cash-futures arbitrage book specifically, so treat the question as unsettled. Many investors report both legs as business income for consistency. Whatever you choose, apply it consistently and take advice before signing the mandate.

Interest and dividends. Fixed deposit interest, which matters in a design like Estee's, and dividends on shares held are taxed at your slab rate.

Splitting the legs between business income and capital gains creates an asymmetry:

• Market rises. The cash leg shows a capital gain and the futures leg a business loss. A non-speculative business loss can be set off against other heads except salary in the same year, so roughly the net spread is taxed.
• Market falls. The cash leg shows a capital loss and the futures leg a business profit. Under section 109(2) of the 2025 Act, a capital loss cannot be set off against any other head. You pay slab-rate tax on the full futures profit and carry the capital loss forward for up to eight years, usable only against capital gains.

In a falling year the tax can exceed what the net spread alone would attract. Treating both legs as business income avoids the mismatch, but at slab rates. Either way, a top-bracket investor generally pays materially more tax on an arbitrage PMS than on an arbitrage mutual fund with the same economics.

The PMS route survives because it has real, if narrow, advantages:

• Very low market sensitivity. Aggregator data shows Estee's I-Alpha with a one-year beta of 0.02.
• Returns close to short-term debt. The three cash-futures approaches in the APMI table returned 6.46% to 7.82% over one year, net of fees.
• Full transparency. Every position, roll and cost appears on your own statements, because, as our explainer on how PMS gains are taxed in your own hands sets out, you are the registered owner.
• Losses are yours to use. A derivatives loss can be set off against other non-salary income in the same year, which can suit investors who already report trading income.
• Customisation. The agreement must state how derivatives are used and in what amount, so the mandate can fit your liquidity and risk limits.
• A higher-rate backdrop. With repo at 5.50% and a tightening stance, funding-driven spreads have support.

For most top-bracket individuals these benefits do not overcome the tax gap. The PMS route is strongest where the investor's rate on business income is close to the equity-fund rate, or where transparency and control are worth paying for.

An arbitrage PMS is easy to misread, because the numbers that make an equity strategy look good or bad do not apply to it. PMS Sahi Hai's tools are useful here, provided you use them with the caveats in this guide.

• Find the strategy and read its facts. The PMS Sahi Hai PMS listing can be filtered by category label and by benchmark, and each strategy page shows trailing returns from one month to five years beside the stated benchmark. There is no arbitrage category, so arbitrage approaches sit under the same Equity or Debt labels SEBI's framework forces on them. Search by manager name, then check the fee terms and exit load.
• Treat "alpha" with care. Strategy pages show the difference between return and stated benchmark as alpha. For an arbitrage book measured against the BSE 500 TRI, that figure mostly tracks the equity market, not the manager's skill. Our guide to PMS benchmark selection explains how to test the fit.
• Read the Nyra Score in context. Nyra, the platform's AI research tool, scores strategies on five pillars. Its published methodology gives 30% of the score to excess return over the stated benchmark across one, three and five years and 15% to consistency, scores some metrics within a peer group defined by asset class and category, and rates nothing with under 12 months of record. A rate-like strategy scored against equity peers or an equity benchmark needs a second look, so ask Nyra how it compares with other low-volatility options rather than relying on one number.
• Check the whole portfolio. If arbitrage would sit beside existing PMS or fund holdings, the portfolio health check takes your holdings list and returns a Nyra Score with a rating for each pillar.

Two honest limits. PMS Sahi Hai's strategy pages do not publish holdings, so they cannot show whether a book is pure cash-futures arbitrage or mixes in directional trades; that must come from the manager in writing. And the site does not calculate tax: the business-income question in this guide is one for your tax adviser. PMS Sahi Hai is an APMI-registered distributor of PMS and AIF products, and Nyra is an analytical tool, not a SEBI-registered investment adviser.

"Hedged" does not mean "risk-free":

• Spread compression. When rates fall or futures traders lose appetite, spreads can drop below costs, and returns can trail a liquid fund or turn briefly negative.
• Execution and legging risk. If one leg fills and the other does not, the position is briefly unhedged.
• Mark-to-market cash calls. A sharp rally can demand large daily margin payments even though the shares have gained the same amount.
• Liquidity limits. PrimeInvestor noted in 2024 that more than 180 stocks had futures but only a few dozen were liquid enough to trade at scale. Capacity is finite.
• Corporate actions. Unexpected dividends, bonuses or splits change the fair basis.
• Regulatory and tax change. The 2026 STT rise shows how quickly economics can shift, and PMS derivatives rules will change again in April 2027.
• Strategy drift. An approach with arbitrage in its name may also take directional positions.
• Tax dispute risk. A later reclassification of the cash leg can change your bill.
• Manager and operational risk. Systems, risk limits and execution discipline carry a strategy with a small margin for error.

Category III alternative investment funds also run arbitrage and market-neutral books, with leverage permitted, but they are a separate pooled structure with their own tax rules; our comparison of long-short funds covers that wrapper.

An arbitrage PMS may be worth a look if you:

• have more than Rs 50 lakh of treasury money you want to keep close to market-neutral
• want every trade visible in your own account
• face a rate on business income close to the 20% equity-fund rate, or already report trading income and understand the set-off rules
• want a mandate shaped around your liquidity needs

It is probably the wrong tool if you:

• are a top-bracket individual comparing it with an arbitrage fund on post-tax return
• need money within days; Estee describes monthly liquidity, and exit loads may apply
• want equity growth, since this is a rate product
• do not want the extra tax reporting that comes with business income

For most investors seeking low-volatility, tax-efficient parking, an arbitrage mutual fund does the same job with lower minimums and equity-fund taxation.

An arbitrage PMS is a legitimate, SEBI-regulated way to run a market-neutral arbitrage strategy in your own name. It earns a spread that follows short-term rates, so expect deposit-like returns. It is also rare: APMI's September 2026 data shows three genuine cash-futures arbitrage approaches plus one mixed one, against nearly Rs 3 lakh crore in arbitrage mutual funds.

Tax decides most cases. The fund wrapper turns arbitrage profits into equity-fund gains, taxed at 20% or 12.5% only on redemption. The PMS wrapper taxes each leg every year, futures profits at slab rates, with an unsettled question over the cash leg. Compare net-of-fee returns, after-tax returns at your own rate, liquidity terms and actual holdings, and ask a tax adviser how the income would be classified for you. PMS Sahi Hai's listing and Nyra can help you line up the facts and frame the questions; the written answers on holdings and tax must come from the manager and your adviser.

If you are weighing an arbitrage PMS, line it up against the alternatives on the measures that matter: net-of-fee return across rate cycles, after-tax return at your own slab, liquidity terms and how closely the strategy sticks to pure arbitrage. Ask each manager for its disclosure document, fee schedule and a sample tax statement. Then decide whether the PMS wrapper adds enough transparency and control to justify its tax cost. Start by finding the strategy on PMS Sahi Hai's PMS listing, read its fees and stated benchmark, and ask Nyra how it stacks up against other low-volatility choices before you commit a rupee.