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The SEBI circular that makes ‘side pocketing’ of mutual funds mandatory has raised several questions about the term and its impact on mutual fund investments. Read on to know about mutual fund side pocketing and how to invest in mutual funds, specifically hedge mutual funds.
What does ‘side pocketing’ in mutual funds mean?
Before we discuss the effects of mutual fund side pocketing on fund houses and investors, let’s talk about the basics first - What is mutual fund side pocketing?
Side pocketing in mutual fund investments enables investors to segregate cash holdings and mutual fund units in a debt portfolio from risky illiquid investments. This ensures that the capital invested in high-risk mutual fund schemes are locked, buying time for the fund to recover the invested capital. The liquid assets can be redeemed by investors. In short, it controls liquidity risks.
SEBI (Securities and Exchange Board of India) has made side pocketing of certain securities mandatory for fund managers to control the rising instances of defaults like Infrastructure Leasing and Financial Services (IL&FS). This initiative will, in turn, have an impact on liquid mutual funds holding IL&FS securities amounting to Rs. 2,800 crore.
Sebi is introducing measures to ensure that the provision is not misused and fund managers do not become reckless. It is yet to notify them, but people familiar with the matter say a fund manager may need the clearance of the board of trustees before investing in such risky assets; the performance of the scheme may also be monitored by the board. Fund managers will be able to use the facility only in select credit events such as in the case of a default in interest payments by the issuer.
Everything has its share of pros and cons, and side pocketing in mutual fund investments is no different. However, investment experts believe that it has more good in store for both fund houses and investors. Therefore, SEBI’s recent decision, passed in December 2018, in making side pocketing mandatory for certain mutual fund schemes is a step towards the right direction.
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