Needing to win by two clear goals, we lead 2-1 against the Gunners but were eventually beaten 3-2.
Earlier, we drew against eventual-winners Charlton and lost to West Ham.
The team included reserve team boss Colin Calderwood, Academy goalkeeping coach Perry Suckling, community and Academy coach David Kerslake, Academy coaches Mark Stimson and Micky Hazard, legendary striker Clive Allen and Clive Wilson.
Colin said: "We needed to win by two clear goals to go through, went 2-1 up but like the West Ham game, they caught us with quick breaks.
"We all thoroughly enjoyed it though and it's great to see and play with some of the lads again."
Charlton beat West Ham in a penalty shoot-out to win the event at Milton Keynes.
Our Masters squad looked on course for a final appearance in Sunday's London Masters until running out of steam against Arsenal.