Side Pocketing in Mutual Funds
- 16th September 2025
- 09:00:00 AM
- 7 min read
Within the first half of 2025, the Indian Mutual Fund market has seen the Asset Under Management (AUM) grow by INR 7 lakh crore, totalling to INR 74.41 lakh crore. Amidst such growth in the sector, protecting your investments in a mutual fund from losses becomes critical.
With side pocketing in mutual funds, your fund manager segregates illiquid, risky, and bad assets to protect the rest from losses. Read this blog to learn about this process in detail.
An Overview of Side Pocketing
As a mutual fund investor, to reduce your risk exposure, the Securities and Exchange Board of India (SEBI) introduced the concept of side pocketing in mutual funds in 2018.
Here is a quick overview of side pocketing that you must know:
- According to the side pocketing concept, your fund manager separates illiquid or troubled assets from the mutual fund portfolio that you invested in.
- You can think of a side pocket in mutual funds as a distinct compartment. Here, your fund manager keeps the problematic assets that might put the overall fund at risk.
- It ensures quick access to money during a crisis or when the main funds underperform. In FY25, 61.33 lakh investors withdrew their SIPs for similar and other reasons. Side pocketing helps by preventing delays caused by illiquid assets.
The Working Process of Side Pocketing in Mutual Funds
The following are some conditions and the segregation process of underperforming funds via the side pocketing mechanism that you must know for a clear understanding:
- To enable side pocketing of mutual funds, the fund must be registered with stock exchanges like the NSE or BSE within 10 working days of its creation.
- To make a debt mutual fund eligible for side pocketing, the scheme must be of INR 1000 crore in terms of its corpus, with at least a 5% exposure to a defaulting business.
- An Asset Management Company (AMC) must amend the respective Scheme Information Document or SID.
- A fund with the side pocketing feature must allow investors a 30-day window to exit the mutual fund. If you exit such a fund within the window, you do not need to pay any exit load.
- After the stipulated window, an AMC must separate the 2 asset categories. One to manage the distressed, risky or illiquid assets and another for the remaining assets.
- If you invest in mutual funds without side pocketing, like many other investors, you might choose to exit the fund to reduce losses. In such cases, the respective fund house must sell its quality and liquid assets to pay you and other investors.
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Types of Assets Typically Placed in a Side Pocket
Before you invest in a mutual fund, you must check its asset allocations. Here are some types of allocated assets that a fund manager might side pocket to protect you from making losses:
- As of FY 25, about 33 bonds defaulted, of which corporate bonds were 28, 4 were public-private, and 1 was a government bond. A mutual fund manager side pockets such assets.
- Fund managers may side pocket assets with low valuation or high volatility. For example, in FY25, only 13 stocks in the Nifty Midcap 100 delivered positive returns. Thus, to manage risks, such assets in a fund might be side-pocketed.
- Fund managers side pocket Illiquid assets that do not have a high amount of buyers and sellers. Such assets are private equities, real estate, stocks with low trade volumes, etc.
- Your fund manager might also side pocket those assets which the regulatory body, like the SEBI or exchanges, temporarily removes.
- Side pocketing in mutual funds also happens if underlying assets are controversial in nature, operating across any delicate sector in the market.
Benefits of side pocketing for investors
Now, as you know what is side pocketing in mutual funds, you must learn how it helps protect the asset values of a fund and subsequently the investors:
- Due to illiquid funds or bad assets, the Net Asset Value (NAV) of a fund falls, and side pocketing helps with this. For example, if a fund’s NAV falls from INR 120 to INR 100 due to a defaulted bond, side pocketing isolates such an asset to protect the rest.
- Side pocketing in mutual funds allows time to recover the value of various distressed assets through orderly exits.
- Segregating bad, illiquid, distressed or risky assets from the rest costs an AMC a one-time loss. This not only helps protect investors from losses but also reduces the redemption rate and maintains fund quality.
- If a defaulting business is liquidated or recovers its capacity to pay its debts, or if bonds recover from defaults, investors can have their money back due to side pocketing.
Drawbacks of Side Pocketing in Mutual Funds
- As an investor, you might get your investments back from side-pocketed assets. However, determining their real worth is complex or uncertain.
- Side-pocketed assets are illiquid by nature. Therefore, as an investor in a mutual fund, you might need to wait indefinitely to get your investment back.
- To cover up poor investment decisions, fund managers might categorise assets unethically as a side pocket asset. This leads to loss of trust among investors.
- Maintaining two different fund sets, such as the main fund and the side pockets, increases operational complexity for fund managers.
Conclusion
When you invest in mutual funds, and especially in bond funds, the concept of side pocketing in mutual funds applies. Here, your fund manager segregates illiquid and bad underlying assets of a fund from the rest of the fund. As bad assets can lower NAV and lead to losses, such a mechanism protects you from further losses.
Frequently Asked Questions
1. What are fund side pockets?
When you invest in a mutual fund, as a risk management mechanism, your fund manager imposes side pocketing. This way, the manager separates bad assets from the rest of the fund, and protects you and the overall fund from losses.
2. What is the difference between a side pocket and a side letter?
Side pocketing separates illiquid assets from the rest in a mutual fund to mitigate risks. A side letter is a contract between a fund manager and a mutual fund investor, which is widely used for closed-end and some of the open-ended funds.
3. What is the difference between a side pocket and a slow pay?
Side pocketing is separating illiquid assets from the rest of the fund. However, in ‘slow pay’, only a certain portion of an illiquid fund is set aside, and the rest is still held with the main fund.
4. When a side pocket is created, which investor receives pro rata shares?
All investors who have bought fund units of the mutual fund when the side pocket is created receive it on a pro rata basis.
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Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.
