Side Pocketing is a term used in MF Parlance when a company defaults that form part of the debt MF scheme. It is the splitting of a debt Mutual Fund unit into a bad unit and good unit when part of the investment of the debt MF scheme goes bad.
In order to illustrate the term further, A Fixed Income Fund scheme with an AUM of Rs 100 crores has invested 5% of the corpus i.e. Rs 5 crores in a company that has defaulted. The rest of the corpus Rs 95 crores is held in good debt paper. Owing to the default by one company, there is a frenzied run for redemption by many large investors in order to avoid further loss when NAV drops. When there is run for redemption by many large investors, the fund managers are forced to sell good debt papers to meet the redemption demand, while bad debt paper continue to remain in the scheme due to it being illiquid and there are no takers. In such a scenario, the percentage holding of bad assets in the total AUM rises. This often leads to steep drop in the NAV, which hits small investor in particular.
To prevent such a scenario, the fund may segregate the debt paper portion of the affected company, while the rest of the good portfolio remains in the debt MF scheme and good paper remains unaffected by the bad paper. When segregated, all the investors of the original debt MF scheme will also get units of the side pocketed fund. The MF will enable listing of the segregated portion of the scheme on a recognized Stock Exchange within 10 days of segregated portfolio and will effect transfer of units when such requests are received by the fund/scheme. As and when the defaulted company pays back bad portion of the scheme, the investors will get their funds back. No fresh subscription or redemption is allowed in the segregated portion of the defaulted paper(s). Fresh subscription as well as redemption would be permitted in the main/good portfolio only based on its NAV.
A statement of account stating the number of units held by the investors in the segregated portfolio along with the NAV of both main and segregated portfolio on the day of segregation shall be sent to the investors within 5 days of segregated portfolio.
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