What Is Side Pocketing in Mutual Funds? (2026)

Side pocketing in mutual funds is the practice of carving a defaulted or sharply downgraded debt instrument out of a scheme's portfolio and holding it separately, so the damage lands on the investors who were there when it happened rather than on whoever redeems first. SEBI's own term for the carve-out is a segregated portfolio. India got the framework in a circular dated December 28, 2018, and it now sits in the Master Circular for Mutual Funds.

What triggers side pocketing in a mutual fund?

The trigger is a credit event at issuer level, and SEBI defines it narrowly. Paragraph 5.5.2 lists three cases, each requiring action by a SEBI registered credit rating agency:

1. Downgrade of a debt or money market instrument to below investment grade.
2. A subsequent downgrade of an instrument already below investment grade.
3. A similar downgrade of a loan rating.

Two clarifications matter for reading a press release correctly. Where credit rating agencies differ, the most conservative rating is the one that counts. And the decision is taken at issuer level but implemented at ISIN level, so the segregation follows the specific instruments.

For unrated debt or money market instruments there is no rating to watch, so the trigger is an actual default of either the interest or the principal amount. The AMC must inform AMFI immediately of that default, and AMFI must pass it to all AMCs, after which any AMC holding the issuer's paper may segregate.

Is a side pocket optional?

Yes, and this is the part most explanations skip. Creation of a segregated portfolio is optional and at the discretion of the AMC. Two conditions gate it:

• The scheme information document must carry an enabling provision, with detailed disclosures in the statement of additional information.
• The AMC must have a detailed policy on creation of segregated portfolios, approved by the trustees.

All new schemes are required to include the enabling provision. So two funds holding the same defaulted bond can behave differently, and the difference is written in their offer documents rather than decided on the day.

What happens on the day of the credit event?

SEBI sets out the sequence, and it runs fast. On the day of the credit event the AMC decides, and if it decides to segregate it must:

• Seek trustee approval before creating the segregated portfolio.
• Issue a press release immediately disclosing its intention to segregate, the instrument involved and the impact on investors, stating that segregation is subject to trustee approval, and put it prominently on the AMC website.
• Suspend subscription and redemption in the scheme until trustee approval arrives, which in no case may exceed 1 business day from the day of the credit event.

Once the trustees approve, the segregated portfolio is effective from the day of the credit event, not from the approval date. A second press release goes out immediately with the full information and is submitted to SEBI, an email or SMS goes to every unit holder, and the NAV of both the segregated and the main portfolio is disclosed from the day of the credit event.

What do unit holders actually get?

Every investor in the scheme as on the day of the credit event is allotted the same number of units in the segregated portfolio as they held in the main portfolio. Those units are not redeemable and not subscribable.

The exit route is the exchange. The AMC must enable listing of the segregated portfolio units on a recognised stock exchange within 10 business days of creation. Recoveries from the issuer, if any, are distributed to segregated portfolio unit holders as they come in.

How to spot a side pocket in the disclosure record

A segregated portfolio is visible in a scheme's own reporting, and it is worth checking before comparing a fund's returns to anything:

• Read the press releases, which are the primary record and carry the credit event date.
• Check the portfolio statement for the segregated holding, which is disclosed separately. See how to read a mutual fund portfolio statement.
• Check both NAVs. Scheme performance and the main portfolio NAV are not the same thing once a side pocket exists, and a scheme can have more than one.
• Check the risk classification. Where the scheme sits in the potential risk class matrix tells you how much credit risk it was permitted to take in the first place, and illiquid securities in a mutual fund covers the adjacent valuation question.

Flock reports the filings and disclosures themselves, each stamped with its date and linked back to the AMC or regulator that published it. Side pocketing in mutual funds is the AMC's decision under SEBI's framework; what any of it means for you is your call to make.