MFs now allowed to segregate distressed assets

The mutual fund regulator Securities and Exchange board of India (SEBI) had mulled to allow the practice of side-pocketing for mutual funds. SEBI had discussed this issue in a meeting with Mutual Funds Advisory Committee (MFAC), but still had not allowed MFs to do side-pocketing. This means that now mutual funds can segregate their distressed assets from those which are good.

Side-pocketing is widely used by hedge funds. In this method, illiquid investments are separated from those which are more liquid and redemptions are capped from such investments. This means that the fund houses can create two separate funds one with good assets and other with stressed assets wherein redemptions won’t be allowed expecting recovery from such assets.

SEBI though has allowed mutual funds for side-pocketing, but it is optional on the mutual funds part. However, approval from trustees is necessary for activating such a portfolio. Now as SEBI has allowed mutual funds to segregate their distressed assets from the good one to protect returns, concerns have been raised that mutual funds must not misuse this norm to their benefit. There is a possibility that mutual funds may take more credit risk. But SEBI's Chairman Anant Tyagi has reassured that enough steps would be taken by SEBI to ensure that side-pocketing is not misused and that the final guideline will mention safeguards pertaining to segregation of stressed assets.