How side pocketing affects mutual fund houses, investors

How side pocketing affects mutual fund houses, investors

News:

The Securities and Exchange Board of India (Sebi) has allowed mutual fund schemes the option of ‘side-pocketing’ which will help both fund houses and investors.

Important facts:

What is side pocketing?

1. It is an accounting method used for segregating bad or illiquid assets from the healthier or liquid ones.
2. It ensures that the money invested in a mutual fund liquid scheme, which is linked to stressed assets, gets locked, until the fund recovers the money from the company.

How will it help investors?

1. After segregation, Net Asset Value (NAV) will reflect the value of the liquid assets, with a separate NAV assigned to the side pocket assets based on an estimate of the realisable value for investors.
2. Investments in the toxic asset will be closed for subscription, while investors can continue to subscribe to or redeem part of their investment in healthy assets.

How will it help fund houses?

After a paper defaults, there are a number of redemption requests. As a result, toxic assets form a larger part of the scheme. Side pocketing will help fund houses manage redemption pressures better, as other holdings will not be impacted.

Issues with Side-pocketing:

1. Side-pocketing may lead to Fund managers taking or credit risks to boost returns.
2. Fund houses can misuse side pockets to protect managers’ fees on the more liquid assets or to hide poorly performing assets or poor liquidity management by its fund managers.