Budget 2026: Arbitrage fund returns may drop 25–30 bps after STT rate revision, says Edelweiss MF

Returns from arbitrage mutual funds are likely to come under pressure following the Union Budget 2026–27’s sharp increase in the Securities Transaction Tax (STT) on derivatives, with the impact estimated at 25–30 basis points (bps) annually, according to Edelweiss Mutual Fund.

In the Budget 2026, Finance Minister Nirmala Sitharaman announced that STT on futures contracts would be raised to 0.05% from 0.02%, while STT on options premium and exercise of options would be increased to 0.15%. The changes, effective April 1, 2026, are aimed at curbing excessive speculative activity in the futures and options (F&O) segment, which has seen explosive growth in recent years.

Bhavesh Jain of Edelweiss Mutual Fund, told CNBC TV18 arbitrage funds are particularly exposed to the STT hike because of their heavy reliance on derivatives. Jain said arbitrage funds typically deploy around 70–75% of their assets in arbitrage trades, most of which are rolled over on a monthly basis.

“The cost will be up by three bps,” Jain said, referring to the direct impact of the incremental STT increase. However, he added that once rollover costs and portfolio churn are factored in, the overall drag on returns becomes more pronounced. “The impact should be around 30 to 32 bps,” he said.

Edelweiss’ Budget analysis estimates that the incremental increase in STT alone works out to roughly 0.03%, but the true impact on arbitrage fund returns is magnified due to the frequent rollover of futures contracts and the inherent turnover in arbitrage strategies. On an annualised basis, this translates into an estimated 0.32% reduction in returns.

Jain said the impact of the STT hike will not be visible immediately, as most arbitrage positions for the current cycle have already been rolled over. “There will be no immediate impact before April. The impact will start reflecting in returns only after the revised STT rates come into effect,” he said.

While arbitrage fund managers may attempt to soften the blow by seeking better rollover spreads, Jain cautioned that the increase in transaction costs is structural and cannot be fully offset. “Arbitrage funds may try to recover part of the increased cost, but some impact on returns is unavoidable,” he said.

Despite the expected decline in returns, Edelweiss believes arbitrage funds could still retain an edge over liquid funds on a post-tax basis. Jain said that although the return gap between arbitrage funds and liquid funds may narrow, it is likely to remain in favour of arbitrage funds due to their more favourable tax treatment. Edelweiss estimates that assuming a 7% return on liquid funds, the post-tax return advantage of arbitrage funds could settle at around 90 basis points, lower than earlier but still meaningful.

The STT hike may also have a spillover effect on other hybrid products that use derivatives, including balanced advantage funds, equity savings funds and hybrid long-short funds, Jain said. However, the impact on these categories is expected to be relatively limited due to their lower dependence on pure arbitrage strategies.

Importantly, Jain noted that arbitrage funds cannot simply switch from futures to options to reduce costs. “Regulations require arbitrage funds to use single-stock futures for arbitrage strategies, so shifting trades to options is not possible,” he said.

Market participants say the STT hike reflects a broader policy intent. Anup Bhaiya, founder of Money Honey Financial Service, said the sharp increase in STT on F&O raises trading costs, curbs speculative volumes and erodes short-term retail and intraday profits. He added that the move, which triggered a market sell-off, is aimed at reducing excessive derivatives speculation while nudging investors towards a longer-term equity focus.

Legal experts also see the change as part of a measured policy recalibration. Rajesh Sivaswamy, Senior Partner at King Stubb & Kasiva, said the higher STT signals the government’s intent to moderate speculative excesses without disrupting genuine investment activity. He noted that while high-frequency and speculative traders may feel the immediate impact, the move is unlikely to materially affect long-term or hedging-oriented participants and is consistent with the Budget’s broader theme of rationalising taxation while safeguarding market stability.

Overall, Edelweiss said the STT hike marks a structural shift for derivative-heavy strategies such as arbitrage funds, reinforcing the need for investors to recalibrate return expectations in a post-Budget environment.