These funds do not work well in all markets
Arbitrage funds do not work well in all markets. They stand out in volatile or buoyant markets, not range-bound ones or bear markets. The arbitrage strategy of buy stock - sell futures will not work if the futures price is trading at a discount to its spot price, which is common during a bearish phase.
Besides the market conditions being conducive to such funds, there are a limited number of stocks permitted to trade in the derivatives segment. The eligibility for a stock to trade in this segment depends upon the criteria laid down by the Securities and Exchange Board of India, or SEBI. So, by and large, there is a limited scope for scouting for opportunity.
This is the reason I am not so sure how long this category can sustain its upper hand. Returns from arbitrage funds depend on attractive arbitrage opportunities being available between the spot market and the futures market. Currently, an industry size of around Rs 5,000-6,000 crore can provide such arbitrage opportunities. If the assets under management in this segment increase, all this money will be chasing similar arbitrage opportunities and hence returns are likely to decline below its current average.