What Are Segregated Portfolios (Side Pocketing) in Debt Funds, and How Do They Protect Investors in Case of Debt Defaults?
Segregated portfolios, often referred to as side pocketing, are distinct portfolios established within a mutual fund to manage specific debt securities impacted by credit events such as downgrades in credit ratings or defaults by issuers. This approach was implemented by SEBI in December 2018 to protect investors in mutual funds in debt. Side pocketing serves as a protective measure for investors in Debt Mutual Funds when these funds possess distressed or defaulting securities. This became increasingly relevant following the Non-Banking Financial Company (NBFC) crisis in 2018.
How Does Side Pocketing Protect Investors?
Think of it as separating “bad” and “good” investments into two separate spaces. Imagine a debt fund holds ₹100 in total and ₹20 of that is invested in a defaulted bond. The fund creates a segregated portfolio for the ₹20, isolating it from the main portfolio, which holds the remaining ₹80. This separation allows the regular portfolio to continue functioning normally, growing with the market, while the ₹20 is kept in the side pocket. If the defaulted bond recovers, investors can still benefit from the return, but it won’t affect the main portfolio.
Segregated portfolios protect investors by ensuring that the distress or default of one investment does not impact the overall fund’s value. The main portfolio continues to operate smoothly, and if the distressed asset recovers, investors can still benefit from the potential upside without affecting the performance of the main portfolio.
For example, Franklin Templeton created a segregated portfolio for its funds in 2020 when DHFL (Dewan Housing Finance Corporation) bonds defaulted. This allowed the fund to isolate the distressed assets while protecting the interests of regular investors.
Understanding concepts like segregated portfolios can be complex, especially when managing debt funds during periods of financial stress. A mutual fund distributor or financial advisor plays a crucial role in helping investors navigate these challenges. They guide you in selecting funds that align with your financial goals, help assess risks, and ensure you’re making informed investment decisions. Their professional guidance helps in managing risks such as defaults and downgrades, ensuring your investments are safer and better aligned with your long-term objectives.
