Arbitrage funds are schemes that try to take advantage of price difference of the stocks between the cash/spot and derivative market. Arbitrage opportunities can be cached in NSE and BSE, during price difference.
When the price movements are volatile, you get arbitrage opportunities. The cash and derivative markets cannot keep up with each other in pricing the same stock and astute money managers can spot these differences and benefit from them. The ability of such a strategy to generate profits depends on the availability of such arbitrage opportunities in the market. The advantage of this approach is that this is a low-risk method of profiting from equity investing. Arbitrage funds reduce the market risk in equities by hedging them using derivatives. They are also classified as equity funds from a taxation perspective for the investor, giving them the benefit of zero taxes for long-term gains. However, since this is essentially meant to be a low-risk strategy and works well primarily in volatile markets, arbitrage funds may not deliver very high returns. In fact, such funds have typically generated returns like debt funds in the past few years.