Segregated portfolio
Also written Side pocketing · Side pocket · Segregated portfolio (side pocketing)
A ring-fenced sub-portfolio holding the debt instrument hit by a credit event, split out of a scheme so that the good assets stay liquid and exiting investors cannot leave the damaged paper behind.
In plain language
A debt scheme holds a bond. The issuer is downgraded. Everybody who reads the news heads for the exit at once — and the scheme can only sell what buyers will take, which is the good paper. The investors who stay are left holding a portfolio in which the bad bond is a much larger share than it was yesterday. They are punished for not panicking.
Segregating the portfolio — side pocketing — stops that. On the day of the credit event the affected instrument is lifted out into a separate portfolio of its own. Every existing investor gets exactly as many units of the segregated portfolio as they held in the main one. The main portfolio carries on normally; the segregated portfolio sits there until money is recovered.
An investor who redeems now gets the main portfolio's NAV in cash and keeps the segregated units. Someone subscribing tomorrow gets main-portfolio units only, and no share of the damaged bond. Both halves of that are the point.
How it works
SEBI permitted this by circular dated 28 December 2018, for debt and money market instruments affected by a credit event — a downgrade by a SEBI-registered credit rating agency. A circular of 7 November 2019 extended it to unrated debt of an issuer with no outstanding rated debt, but only on an actual default of interest or principal. Every scheme launched after 7 November 2019 must carry the enabling clause in its SID.
Creation is optional and at the AMC's discretion, and needs trustee approval. Once approved: the segregation is effective from the day of the credit event, a press release goes out immediately, the NAV of both portfolios is declared daily from that day, and the units of the segregated portfolio must be listed on a recognised stock exchange within 10 working days. No subscription or redemption is permitted in the segregated portfolio — listing is the only exit.
On costs: the AMC may charge no investment and advisory fee on the segregated portfolio. TER excluding the investment and advisory fees may be charged pro-rata only upon recovery, capped at the simple average of those same expenses charged daily on the main portfolio while the segregated portfolio existed. Note that this is the workbook's own construction, and it is about which expenses may be levied here — it is not the slab table, which caps the base expense ratio. Legal recovery charges go in proportion to the amount recovered, within the main portfolio's TER limits, with any excess borne by the AMC. None of it may ever be charged to the main portfolio.
A worked example
The workbook's case. A debt scheme on 30 September 2019 holds:
| Security | Rating | Qty | Price (Rs) | Market value (Rs) |
|---|---|---|---|---|
| 8.00% XYZ Ltd NCD | CRISIL A- | 25,000 | 49.552 | 12,38,800 |
| 7.80% AVC Ltd NCD | CRISIL AAA | 25,000 | 101.021 | 25,25,525 |
| 7.65% UYV Ltd NCD | CRISIL AAA | 21,000 | 100.022 | 21,00,462 |
| 8.10% MNO Ltd NCD | CRISIL A- | 30,000 | 99.548 | 29,86,440 |
| Cash and equivalents | 11,50,000 | |||
| Net assets | 1,00,01,227 |
With 10,000 units outstanding, NAV is Rs 1000.1227.
That day XYZ Ltd is downgraded from A- to C and the bond is marked down 50 per cent, from Rs 99.105 to Rs 49.552. The AMC segregates it:
| Main portfolio | Segregated portfolio | Total | |
|---|---|---|---|
| Net assets (Rs) | 87,62,427 | 12,38,800 | 1,00,01,227 |
| Units | 10,000 | 10,000 | |
| NAV per unit (Rs) | 876.2427 | 123.88 | 1000.1227 |
An investor holding 500 units now holds 500 units of each. If she redeems, she receives 500 × 876.2427 = Rs 4,38,121 from the main portfolio and still holds 500 segregated units, which she can only sell on the exchange. If XYZ Ltd eventually pays in full, the segregated NAV recovers towards Rs 247.76 per unit and she gets the upside; if it pays nothing, the Rs 123.88 goes to zero — but the main portfolio was never dragged down with it.
Why NISM asks about it
Chapter 10 (Risk, Return and Performance of Funds), section 10.8.2, carries the full mechanics and this illustration; Chapter 7 section 7.6 adds the NAV, TER and pricing rules. Expect questions on what triggers segregation (a credit event, or actual default for unrated paper), who approves it, the 10-working-day listing deadline, and the fee position — that no investment and advisory fee may be charged on the segregated portfolio.
Common exam traps
- It is optional, not automatic. If the trustees do not approve the proposal, subscriptions and redemptions are processed on the total portfolio NAV as if nothing had happened.
- A redeeming investor keeps the segregated units. She exits the main portfolio only.
- A new subscriber gets main-portfolio units only and no exposure to the damaged bond.
- Units of the segregated portfolio cannot be redeemed — the exchange listing is the sole exit, and the workbook warns that listing does not guarantee liquidity or a price near NAV.
- For rated paper the trigger is a downgrade; for unrated paper it is an actual default. They are not the same test.
- Segregation is not the same as gating. Gating restricts redemptions across the scheme in a market-wide crisis, for at most 10 working days in any 90-day period, and leaves the first Rs 2 lakh of any request untouched.
- No investment and advisory fee on the segregated portfolio, and other TER only on recovery — not from day one.
Where this is taught
- Series II-B · Chapter 11: Operational Concepts of Mutual Fundsintroduced here
- Series V-D · Chapter 4: Legal and Regulatory Frameworkintroduced here
- Series V-A · Chapter 4: Legal and Regulatory Frameworkintroduced here
- Series X-B · Chapter 13: Tax provisions for Special Casesintroduced here
- Series V-B · Chapter 10: Legal and Regulatory Environmentintroduced here
- Series V-A · Chapter 7: Net Asset Value, Total Expense Ratio and Pricing of units
- Series V-D · Chapter 7: Net Asset Value, Total Expense Ratio and Pricing of units
- Series V-D · Chapter 10: Risk, Return and Performance of Funds
- Series V-A · Chapter 10: Risk, Return and Performance of Funds
Related terms
- Credit riskThe risk that a borrower fails to meet its obligations on a debt instrument — the risk credit rating agencies exist to grade, and the one that triggers a segregated portfolio in a mutual fund.
- Net Asset ValueThe net assets of a mutual fund scheme divided by the number of units outstanding — what one unit of the scheme is worth on a given day, after every liability except the unitholders' own.
- Total Expense RatioThe all-in annual cost of a mutual fund scheme as a percentage of daily net assets — the base expense ratio plus brokerage, transaction cost and statutory levies — charged to the scheme, not billed to the investor.
- Credit eventThe trigger for creating a segregated portfolio under the SEBI circular of 28 December 2018.
- GatingA measure available only in a market-wide crisis — liquidity failure across almost all securities, market failure or exchange closure, or force majeure operational failure — never for one illiquid security or a poor…
- Main portfolioThe scheme portfolio excluding the segregated portfolio.
- Generally available informationInformation accessible to the public on a non-discriminatory basis — the opposite pole of unpublished price sensitive information, and expressly not including unverified media reports.