Should I invest in Income Plus Arbitrage Fund of Funds to lower tax liability?

As tax rules change, AMCS develop innovative ideas to attract customers. The latest move is creating a new type of fund of funds (FOF), an MF that invests in other MFs (from the same or different AMCs).

Since debt mutual fund capital gains are always taxed at the slab rate, this new FOF creates a “hybrid” taxed at a lower rate, regardless of duration. The FOF will hold not more than 65% Debt Mutual fund schemes and not less than  35% Arbitrage Schemes.

This way, the fund will be neither equity nor debt-oriented. The taxation will be per the slab for gains from units less than or equal to two years old. For gains from older units, it will be a 12.5% LTCG tax. See more details here: How will fund of funds be taxed from July 23rd 2024?

The question now is, should I prefer the Income Plus Arbitrage Fund of Funds instead of debt funds? The short answer is no for most investors, especially those inexperienced with debt funds. This is because the risk is higher, and we should never increase risk in the name of saving tax.

Our recommendation is also valid for those who wish to switch from Parag Parikh Conservative Hybrid Fund to the “debt-heavy” Parag Parikh Dynamic Asset Allocation Fund, as the risk is significantly higher. Such a move is ‘ok’ for experienced investors, but the risk is higher. Ps. I have made this switch, but I am aware of the risk, and more importantly, the risk is acceptable for my goal.

Why am I not a fan of Income Plus Arbitrage Fund of Funds?

1. Any fund of funds is problematic. The underlying funds keep changing, and the risks also vary. The underlying funds themselves change strategy from time to time.
2. In addition, the debt FOF may become a dynamic bond fund, changing underlying funds based on interest rate movements and the credit rating profile based on market conditions.

Is it necessary to get into such complexity only to save some tax? It makes no sense to us.

Let us see some examples.

Axis Income Plus Arbitrage Active FOF says, “invests in a variety of debt-oriented mutual fund schemes of different AMCs through a single fund. The fund actively manoeuvres duration and credit based on the prevailing market environment”

This is its portfolio as of April-end 2025.

I have to worry about what the fund manager is doing, and then I have to worry about what the fund managers of the underlying funds are doing. Sorry, too much trouble. No, thank you.

SBI Income Plus Arbitrage Active FOF says, “Investments in actively managed debt-oriented schemes will be based on an evaluation of macroeconomic factors, policy rates, liquidity expectations, and demand-supply dynamics, enabling active management of credit risk and interest rates, as well as their likely evolution over the medium term” The fund is just a few days old and underlying fund information is unknown.

HDFC Income Plus Arbitrage Active FOF says, “Scheme will actively manage allocation by adjusting the portfolio duration and credit risk based on the interest rate outlook, decisions made during RBI monetary policy, shape of the yield curve, and other factors as deemed suitable by the Fund Manager”

The fund currently holds

HDFC Corporate Bond Fund – Growth Option – Direct Plan 62.85%
HDFC ARBITRAGE FUND – Direct Plan – Wholesale Growth Option 36.66%

Before you think, “Two funds are not bad, ” I want to remind you that things change fast.

DSP Income Plus Arbitrage FoF

DSP Arbitrage Fund(G)-Direct Plan 35.9867%
DSP Banking & PSU Debt Fund(G)-Direct Plan 62.3754%

ICICI Pru Income Plus Arbitrage Active FOF

ICICI Pru Corp Bond Fund(G)-Direct Plan 60.1607%
ICICI Pru Equity-Arbitrage Fund(G)-Direct Plan 38.0084%

Kotak Income Plus Arbitrage FOF

Kotak Corporate Bond Fund(G)-Direct Plan 59.1219%
Kotak Equity Arbitrage Fund(G)-Direct Plan 39.6616%
Kotak Gilt Fund(G)-Direct Plan 0.0450%

UTI Income Plus Arbitrage Active FoF

UTI Arbitrage Fund(G)-Direct Plan 34.8871%
UTI Corporate Bond Fund(G)-Direct Plan 58.9237%

DSP Income Plus Arbitrage FoF

DSP Arbitrage Fund(G)-Direct Plan 35.9867%
DSP Banking & PSU Debt Fund(G)-Direct Plan 62.3754%

Aditya Birla SL Debt Plus Arbitrage FOF

Aditya Birla SL Arbitrage Fund(G)-Direct Plan 38.6958%
Aditya Birla SL Banking & PSU Debt(G)-Direct Plan 39.6495%
Aditya Birla SL Corp Bond Fund(G)-Direct Plan 10.9621%
Aditya Birla SL Floating Rate Fund(G)-Direct Plan 12.9949%

HSBC Income Plus Arbitrage Active FOF

HSBC Arbitrage Fund(G)-Direct Plan 37.9907%
HSBC Banking and PSU Debt Fund(G)-Direct Plan 13.9892%
HSBC Dynamic Bond Fund(G)-Direct Plan 10.5100%
HSBC Gilt Fund(G)-Direct Plan 16.0306%
HSBC Short Duration Fund(G)-Direct Plan 19.9874%

Bandhan Income Plus Arbitrage FoF

Bandhan Arbitrage Fund(G)-Direct Plan 45.4471%
Bandhan Corp Bond Fund(G)-Direct Plan 71.8199%
Cash & Cash Equivalent 0.0015%
Net Current Asset -17.5166% (this is usually a hedged holding)

Axis says its FOF can be used beyond 2Y, while ICICI recommends 5 years and above. This can be tricky because if the FOF fund manager is going to play the duration game, then the risk profile would change.

While we recommend against investing in this category, if you “must” choose a fund, please follow these steps (assuming you have some experience in debt funds).

1. Check the holding for a few months and see how stable it is.
2. Check the credit quality of the underlying funds. If it fluctuates too much or suddenly decreases, avoid.
3. Invest in such only for long-term goals. Do not use for short-term goals.
4. Please avoid the regular plan as the commissions are expected to be high (and therefore the “recommendations”). The ICICI fund direct plan has a TER of 0.03%. The regular plan has a TER of 0.28%. Now add the TER of the underlying direct plans (which will be baked into their NAV).
5. Look for a low-cost income plus arbitrage FOF with a narrow mandate and portfolio that does not change too much in economic and market conditions. The more passive the FOF, the better you sleep.

I am glad MF AMCs want to lower our tax burden, but they should also produce uncomplicated products.