Segregated portfolios (side pockets) in mutual funds
When one issuer's paper goes bad, the scheme can wall it off. How the split works and what the RTA runs afterwards.
A segregated portfolio, popularly called a side pocket, lets a debt or money market scheme separate a troubled instrument from the rest of its holdings. When an issuer faces a credit event, the AMC can move that issuer's paper into a separate portfolio. The main portfolio carries on as normal. The segregated one waits for whatever money can be recovered.
The aim is fairness and liquidity. Without a side pocket, investors who redeem early take out full value while those who stay bear the whole loss, and new investors buy into a problem they had no part in. For the RTA, segregation means running what is in effect a close-ended fund carved out of the main scheme: separate NAV, separate statements, and payouts when recoveries come in.
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What can trigger segregation
Rated debt or money market instrument
Trigger
Credit event: downgrade below investment grade by a SEBI-registered credit rating agency
Source
SEBI circular, December 28, 2018
Unrated debt or money market instrument of an issuer with no outstanding rated paper
Trigger
Actual default of interest or principal
Source
SEBI circular, November 7, 2019
| Instrument | Trigger | Source |
|---|---|---|
| Rated debt or money market instrument | Credit event: downgrade below investment grade by a SEBI-registered credit rating agency | SEBI circular, December 28, 2018 |
| Unrated debt or money market instrument of an issuer with no outstanding rated paper | Actual default of interest or principal | SEBI circular, November 7, 2019 |
How a segregated portfolio is created
- 1
1. The SID must allow it
The scheme's Scheme Information Document must carry a provision for segregation with adequate disclosures. Since the November 2019 circular, every new scheme must include this enabling provision.
- 2
2. The event happens
A downgrade below investment grade, or for unrated paper, an actual default. For unrated paper, the AMC informs AMFI immediately, and AMFI informs all AMCs.
- 3
3. The AMC decides
Creation is optional and at the AMC's discretion. The action must be approved by the trustees. It is done issuer by issuer and implemented at the ISIN level.
- 4
4. Effective from the event date
The segregated portfolio takes effect from the day of the credit event.
- 5
5. Investors are told
An email or SMS goes to all unitholders of the scheme, and scheme documents carry adequate disclosure.
- 6
6. Listing within 10 working days
Units of the segregated portfolio are listed on a recognised stock exchange within 10 working days of creation, and transfers are enabled, so investors have an exit.
Worked example: splitting a scheme
Illustrative numbers only. A debt scheme holds ₹500 crore. ₹25 crore of it is paper of Issuer X, which is downgraded below investment grade.
Holds
Main portfolio
₹475 crore of all other securities
Segregated portfolio
₹25 crore of Issuer X paper
NAV
Main portfolio
Declared daily
Segregated portfolio
Declared daily
Subscriptions and redemptions
Main portfolio
Open as usual
Segregated portfolio
Not allowed; exit only by selling the listed units on the exchange
Who holds it
Main portfolio
Existing investors, plus anyone who invests after segregation
Segregated portfolio
Unitholders at the time of segregation; it takes no new subscriptions
Fees
Main portfolio
Unchanged
Segregated portfolio
No investment and advisory fee; other TER charged pro rata only on recovery
If Issuer X pays ₹10 crore later
Main portfolio
No effect
Segregated portfolio
Distributed immediately to holders in proportion to their holding
| Point | Main portfolio | Segregated portfolio |
|---|---|---|
| Holds | ₹475 crore of all other securities | ₹25 crore of Issuer X paper |
| NAV | Declared daily | Declared daily |
| Subscriptions and redemptions | Open as usual | Not allowed; exit only by selling the listed units on the exchange |
| Who holds it | Existing investors, plus anyone who invests after segregation | Unitholders at the time of segregation; it takes no new subscriptions |
| Fees | Unchanged | No investment and advisory fee; other TER charged pro rata only on recovery |
| If Issuer X pays ₹10 crore later | No effect | Distributed immediately to holders in proportion to their holding |
Free account, this exam preselected.
Why the example matters
An investor who redeems from the main portfolio the week after segregation does not lose the claim on Issuer X. That claim sits in the segregated units. A new investor who buys after segregation gets no share of a later recovery, because they never carried the risk. That is the fairness the rule is built for.
The RTA's duties after segregation
- checkCalculate the NAV of the segregated portfolio
- checkInform investors of that NAV
- checkIssue account statements for the segregated portfolio
- checkDistribute any money recovered, in proportion to holdings
- checkEnsure TER compliance and reporting
- checkKeep the main portfolio running with no restriction on purchase and redemption
Tax and safeguards
- check_circleCapital gains or losses are calculated from the date of original investment, not from the date of segregation.
- check_circleThe AMC must periodically review the action taken to recover the investment in the segregated portfolio.
- check_circleSEBI has said the facility must not encourage AMCs to take undue credit risk. Misuse is treated as serious.
How the Series II-B exam tests this
- check_circleDefinition of credit event: downgrade below investment grade by a SEBI-registered CRA.
- check_circleThe 2019 change: unrated paper of an issuer with no rated paper can be segregated only on actual default.
- check_circleOptional, not mandatory: creation is at the AMC's discretion, with trustee approval and an SID provision.
- check_circleListing within 10 working days; no subscription or redemption in the segregated portfolio.
- check_circleFees: no investment and advisory fee; other TER only pro rata on recovery.
- check_circleCapital gains period runs from the original investment date.
- check_circleWhich RTA duty fits: separate NAV, separate statements, distributing recoveries.
FAQs
What is a segregated portfolio in a mutual fund?expand_more
A separate portfolio created from a debt or money market scheme to hold an issuer's paper after a credit event. The main portfolio continues normally. The segregated one takes no new subscriptions, so only unitholders at the time of segregation share in any recovery.
Can I redeem units of a segregated portfolio?expand_more
No. Subscription and redemption are not allowed in the segregated portfolio. To give an exit, the AMC lists its units on a recognised stock exchange within 10 working days of creation and allows transfers.
Is creating a side pocket compulsory?expand_more
No. Under SEBI's November 2019 circular it is optional and at the AMC's discretion. It can be done only if the SID provides for it, and the trustees must approve.
How is capital gain worked out on segregated units?expand_more
From the date of the original investment in the scheme, not from the date the portfolio was segregated.
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