Hello Readers!
Many fund houses have incorporated the option of Side-Pocketing, in their Debt Schemes, in order to separate the bad securities or say investments, from the good ones. This helps investors to save their investment portfolio from getting in a loss.
But before you opt the option of Side-pocket for your debt schemes, it is important to know about them, how do they work, how are they useful to debt investors, and is it necessary to go side-pocketing with your debt schemes.
What Is Side-Pocketing?
A Side-Pocket is an option that allows, the mutual fund house to segregate the good liquid fund from the bad assets, in a debt portfolio, that can be affected by the credit profile of underlying instruments. Side-pocketing in debt schemes helps small investors to save their investment from the sudden exit of large investors. It does help to stabilize the Net Asset Value (NAV) and reduce redemptions in the schemes. In the case of sudden illiquidity, the side pocket provides a cushion to the liquid portfolio.
How it is done?
To avail the option of Side-pocket in Debt Schemes, it is essential for the Asset Management Company, to raise a proposal to create a side pocket to amend the Scheme Information Document (SID) and allow an exit window of 30 days. Once the proposal is approved, the AMC can separate papers that are liquid or in default category from all other instruments in the portfolio that are liquid. After this process, two kinds of schemes are created, one that contains illiquid papers and the other that hold good investments.
Why Is This Useful to Investors?
Suppose a fixed-income fund that has a corpus of Rs 1000 crore, with 5% exposure to a company by default, and just because of default by one company, many investors tend to redeem money, from the scheme to prevent further loss. And in order to pay the returns to these investors, the scheme is forced to sell good papers, which ultimately raises the percentage of bad assets holding, in the portfolio. But in the case of side-pocketing, if the segregation of the bad asset is done, investors do not rush in to redeem, their portion, also when the affected company pays back, the investors will get their money back.
Is side-pocket compulsory?
Side-pocket is not made mandatory to adopt for all investments and by all AMC’s, by SEBI (Security Exchange Board of India). It is completely upon AMC’s whether they want to go with a side-pocket option or not. When a bond slips into non-investment grade, AMCs mainly have two options, first, some of the AMC’s may write down the value of an investment, and second, some AMC’s may side pocket it.
Side-pocket, being beneficial to small investors, by protecting their portfolio, from the sudden exit of large investors, at the same time it should be used with caution. Analysts say that since valuations of the illiquid or defaulted asset are controversial, NAV of the illiquid asset will not be discoverable thus investors will often find it difficult to track two sets NAV. Thus, it is necessary for AMC to not misuse the facility of Side-pocket in Debt Funds.
If you are a debt fund investor, do consider side-pocketing your funds, in order to prevent the loss from the sudden exit of large investors from your fund.
You can contact us at Shri Ashutosh Securities Pvt Ltd., for any assistance, we are here to help you in any way possible.
Happy Investing!
(Mutual Fund investments are subject to market risk Illustrations are for example only, there is no guarantee of returns. Past performance is not an indicator/guarantee to future returns).