Side Pocketing in Debt Mutual Funds: What It Is and When an AMC Uses It
Blog by Aliceblue News Desk
20 October 2026
10 minutes
You open your debt fund one morning, and the NAV has dropped. Interest rates haven’t moved. One bond the fund holds was downgraded, and investors are rushing to exit.
This is the problem side pocketing solves. In a side pocketing debt mutual fund, the fund house (AMC) moves the troubled bond into a separate portfolio, called a segregated portfolio. The rest of your money stays in the main fund. This blog explains how it works, with real Indian cases and a worked example.
Quick Answer
Side pocketing means the AMC moves one downgraded or defaulted bond into a separate portfolio with its own NAV. Every investor in the scheme that day gets the same number of units in it as they hold in the main fund. Nobody can buy or redeem those units from the AMC. Money recovered from the issuer is shared in proportion to units held.
Table of Contents
- What Is Side Pocketing in a Debt Mutual Fund?
- What Happens When a Bond Defaults in a Mutual Fund?
- How a Segregated Portfolio Mutual Fund Works
- Example With Numbers
- Debt Fund Default in India: Real Cases
- Key Features
- Advantages
- Risks and Limitations
- Side Pocketing vs No Side Pocketing
- Tips for Beginners
- Common Mistakes to Avoid
- Who Should Know This?
- Conclusion
- FAQs
What Is Side Pocketing in a Debt Mutual Fund?
Side pocketing is the separation of one bad bond from the rest of a debt fund. The Securities and Exchange Board of India (SEBI), the market regulator, calls the result a segregated portfolio. SEBI allowed it through a circular dated 28 December 2018.
A few basics help here. A bond is a loan you give to a company, and the company promises interest and your money back on a set date. A debt fund pools investor money and buys many such bonds. NAV is the price of one unit of the fund.
Rating agencies grade how safe each borrower is. “Investment grade” means the risk of nonpayment is low. “Below investment grade” means the risk is high. When a bond slips to that level, it becomes hard to sell and hard to value, and one bond can drag down the whole fund.
What Happens When a Bond Defaults in a Mutual Fund?
The fund first cuts the bond’s value to what it could realistically recover. That cut shows up in the NAV at once. This is how any debt fund default in India reaches your account.
Without a side pocket, the cut hits one NAV. Investors who sell fast may leave at a price that’s still too high. The fund may then have to sell its good bonds to pay them, and the investors who stay are left with a weaker fund.
With a side pocket, the bad bond is kept apart. The good bonds stay in the main portfolio. Everyone who held units that day shares the loss, and not just the people who stayed.
How a Segregated Portfolio Mutual Fund Works
These steps follow SEBI’s framework and the notice Tata Mutual Fund issued in 2019.
- A credit event happens. A SEBI-registered rating agency downgrades the bond to below investment grade. For an unrated bond, the trigger is an actual default on interest or principal.
- The AMC checks its documents. Creating a segregated portfolio is optional. The scheme’s offer document must allow it, and the AMC needs a policy approved by its trustees. Trustees are the group that watches over the fund for investors.
- The trustees approve. The AMC announces the plan by press release.
- Two NAVs begin. The AMC publishes a separate NAV for the main portfolio and for the segregated portfolio.
- You get matching units. If you hold 10,000 units on that day, you get 10,000 units in the segregated portfolio.
- Dealing stops in the side pocket. After creation, nobody can subscribe to or redeem units of the segregated portfolio.
- The units get listed. The AMC lists them on a recognised stock exchange within 10 working days and allows transfers.
- Recoveries are paid out. Any money recovered, whether partial or full, goes to investors in proportion to their holding.
If you redeem your main units later, the side pocket units stay with you.
Example With Numbers
This is a made-up example. The figures are for illustration only.
A fund holds ₹1,000 crore across 100 crore units, so the NAV is ₹10.00. A ₹100 crore bond from “XYZ Finance” is downgraded to below investment grade. The fund now values it at ₹40 crore.
Item | Main portfolio | Segregated portfolio |
Value | ₹900 crore | ₹40 crore |
Units | 100 crore | 100 crore |
NAV per unit | ₹9.00 | ₹0.40 |
You hold 10,000 units, worth ₹1,00,000 before the downgrade.
- Main units: 10,000 × ₹9.00 = ₹90,000
- Side pocket units: 10,000 × ₹0.40 = ₹4,000
- Total: ₹94,000
Say you redeem your main units and take ₹90,000. You still hold 10,000 side pocket units. Later, XYZ repays ₹30 crore. That is ₹0.30 for each segregated unit, so you receive ₹3,000.
Now picture the same fund with no side pocket. The NAV simply falls to ₹9.40, because ₹940 crore divided by 100 crore units is ₹9.40. If you sell, you get ₹94,000 and walk away from the bond. Any recovery later goes to the investors who stayed. A bar chart with three bars (₹10.00 before, ₹9.00 main, ₹0.40 side pocket) would show this clearly.
Debt Fund Default in India: Real Cases
Tata Mutual Fund and DHFL, 2019. Rating agencies cut Dewan Housing Finance Limited (DHFL) to default ‘D’ on 5 June 2019. Tata Mutual Fund created segregated portfolios for DHFL bonds in three schemes: Tata Treasury Advantage Fund, Tata Medium Term Fund and Tata Corporate Bond Fund. Before that, it gave investors 30 days to exit with no exit load, ending on 14 June 2019. It was reported as the first side pocket in India.
Vodafone Idea, 2020. UTI Mutual Fund and Nippon India Mutual Fund side pocketed their Vodafone Idea exposure in February 2020. The segregation took effect from 17 February 2020.
Franklin Templeton. It created five segregated portfolios for Vodafone Idea debt, and later reported receiving ₹1,398 crore from the company. It did not use side pocketing everywhere. In 2020, it wound up six other debt schemes instead.
Key Features
- It’s the AMC’s choice. SEBI allows it but doesn’t force it.
- The documents must allow it. The scheme’s offer document needs an enabling clause.
- Two NAVs. Each portfolio shows its own NAV.
- No dealing with the AMC. Segregated units can’t be bought or redeemed from the AMC.
- A fixed set of owners. Only investors holding units on the creation day get side pocket units.
- Strict conditions. The Supreme Court has upheld SEBI’s action against Kotak Mutual Fund for creating segregated portfolios without meeting the circular’s mandatory conditions.
Advantages
- Fair treatment. Early sellers can’t leave the entire loss to others.
- Less forced selling. The fund doesn’t have to dump good bonds in a rush.
- Recovery reaches the right people. If the issuer repays, the money goes to those who held units during the problem.
- A clearer view of the main fund. You can judge the health of bonds on their own.
Risks and Limitations
Money risks
- You can’t redeem side pocket units from the AMC. To exit, you have to sell on the exchange, where buyers may be few and prices low.
- Recovery can take years, and you may get back only part of your money.
- The side pocket NAV is an estimate. If the AMC values the bond too high or too low, some investors gain, and others lose.
Behaviour risks
- Many investors forget the extra units, because they show up as a separate line in the statement.
- Some assume a side pocket means no loss. You still lose money on that bond.
Rule risks
- AMCs don’t always use it. Franklin Templeton wound up six schemes in 2020 instead.
- Breaking SEBI’s conditions can lead to action, as the Kotak case shows.
Side Pocketing vs No Side Pocketing
Parameter | With side pocket | Without side pocketing |
Bad bond | Kept in a separate portfolio | Stays inside the main fund |
Main NAV | Excludes the bad bond | Carries the full markdown |
Who gets recovery | Investors on the creation day | Whoever holds units later |
Exit | Main units via AMC, side units on exchange | All units at one NAV |
Pressure on the fund | Lower | Higher if many investors exit |
Tips for Beginners
- Check a debt fund’s holdings and ratings in its factsheet before you invest.
- See how much sits with one borrower. A big share in a low rated name is a warning.
- Skip credit risk funds, which take more risk for higher interest, for money you need within a year.
- If your fund announces a side pocket, save the statement and track the side pocket NAV.
- Don’t judge a fund by yield alone. A high yield usually means weaker bonds.
- Keep your emergency money in safer options like liquid funds or a bank account.
Common Mistakes to Avoid
- Treating debt funds as risk-free. They carry credit risk. Read what the fund owns.
- Selling in panic on a headline. Read the AMC’s notice first. The main portfolio may be fine.
- Forgetting side pocket units. They still belong to you.
- Putting all your debt money in one credit risk fund. Spread it across categories.
- Chasing the top yield. Check the rating mix before the return.
Who Should Know This?
Anyone holding debt funds should know this, especially holders of credit-risk, corporate bond, and low-duration funds. It matters most if you can wait years for a recovery.
It matters less in overnight and government securities funds, where such events are rare. Don’t depend on a side pocket if you may need all your money back soon.
Conclusion
Side pocketing lets a fund house isolate a defaulted bond so it doesn’t drag down the entire debt fund. The bad bond moves into a segregated portfolio with its own NAV, while the healthy bonds stay in the main scheme. You still lose money on that bond, and recovery can take years. Before you buy a debt fund, read its holdings and ratings. Treat debt fund default in India as a real possibility, and keep money you need soon in lower-risk options.
Frequently Asked Questions
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