{"id":3460,"date":"2021-07-26T17:28:00","date_gmt":"2021-07-26T11:58:00","guid":{"rendered":"https:\/\/www.tickertape.in\/blog\/?p=3460"},"modified":"2021-09-01T18:37:11","modified_gmt":"2021-09-01T13:07:11","slug":"side-pocketing","status":"publish","type":"post","link":"https:\/\/www.tickertape.in\/blog\/side-pocketing\/","title":{"rendered":"Side Pocketing in Mutual Funds \u2013 Overview, How It Works, Examples"},"content":{"rendered":"\n<p>One of the main advantages of <a href=\"https:\/\/www.tickertape.in\/blog\/how-to-invest-in-mutual-funds-beginners-guide-to-mutual-fund-investment\/?utm_source=blog&amp;utm_medium=article\">mutual fund investments<\/a> is the professional fund management that they encompass. The goal of mutual fund managers is to provide maximum benefits to investors. In this effort, they resort to various strategies. Side pocketing is one such strategy.<\/p>\n\n\n\n<p>It is an uncommon terminology but side pocketing proves to be quite a beneficial activity. Let\u2019s understand what this involves.<\/p>\n\n\n\n<p><strong>This article covers:<\/strong><\/p>\n\n\n\n<ul><li><a href=\"#what\">What is side pocketing?<\/a><\/li><li><a href=\"#how\">How does side pocketing work?<\/a><\/li><li><a href=\"#benefits\">Benefits of side pocketing<\/a><\/li><li><a href=\"#drawbacks\">Drawbacks of side pocketing<\/a><\/li><li><a href=\"#side\">Side pocketing &#8211; important things to know<\/a><\/li><\/ul>\n\n\n\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_66_1 counter-hierarchy ez-toc-counter ez-toc-custom ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title \" >Table of Contents<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/www.tickertape.in\/blog\/side-pocketing\/#What-is-side-pocketing\" title=\"What is side pocketing?\">What is side pocketing?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/www.tickertape.in\/blog\/side-pocketing\/#How-does-side-pocketing-work\" title=\"How does side pocketing work?\">How does side pocketing work?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/www.tickertape.in\/blog\/side-pocketing\/#Benefits-of-side-pocketing\" title=\"Benefits of side pocketing\">Benefits of side pocketing<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/www.tickertape.in\/blog\/side-pocketing\/#1-Fair-for-investors\" title=\"1. Fair for investors\">1. Fair for investors<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/www.tickertape.in\/blog\/side-pocketing\/#2-Stability\" title=\"2. Stability\">2. Stability<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/www.tickertape.in\/blog\/side-pocketing\/#3-Protects-liquidity\" title=\"3. Protects liquidity\">3. Protects liquidity<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/www.tickertape.in\/blog\/side-pocketing\/#Drawbacks-of-side-pocketing\" title=\"Drawbacks of side pocketing\">Drawbacks of side pocketing<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/www.tickertape.in\/blog\/side-pocketing\/#Side-pocketing-%E2%80%93-important-things-to-know\" title=\"Side pocketing &#8211; important things to know\">Side pocketing &#8211; important things to know<\/a><\/li><\/ul><\/nav><\/div>\n<h2 class=\"wp-block-heading\" id=\"what\"><span class=\"ez-toc-section\" id=\"What-is-side-pocketing\"><\/span><strong>What is side pocketing?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Side pocketing is an activity undertaken by the fund managers of a debt mutual fund. In such funds, instruments whose credit rating falls are segregated from other instruments and put in a different portfolio. This activity of picking instruments with a reduced credit rating and shifting them to another portfolio is called side pocketing.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"how\"><span class=\"ez-toc-section\" id=\"How-does-side-pocketing-work\"><\/span><strong>How does side pocketing work?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>To understand the working of side pocketing, you need to have a little understanding of how <a href=\"https:\/\/www.tickertape.in\/blog\/things-to-consider-debt-mutual-fund\/\">debt mutual funds<\/a> work.&nbsp;<\/p>\n\n\n\n<p><a href=\"https:\/\/www.tickertape.in\/blog\/best-debt-mutual-funds-in-india\/\">Debt mutual funds<\/a> <a href=\"https:\/\/www.tickertape.in\/blog\/why-should-you-prioritise-investing\/\">invest<\/a> their portfolio in debt instruments, i.e., investments that usually carry a fixed rate of interest income. The fund manager buys and sells debt instruments to provide a balanced risk-reward opportunity to investors.<\/p>\n\n\n\n<p><a href=\"https:\/\/www.tickertape.in\/blog\/what-are-debt-funds\/\">Debt funds<\/a> do not face risks of price fluctuation and <a href=\"https:\/\/www.tickertape.in\/blog\/volatility\/\">volatility<\/a> that are rampant in the <a href=\"https:\/\/www.tickertape.in\/blog\/what-are-equity-shares-meaning-types-features-limitations-and-more\/?utm_source=blog&amp;utm_medium=article\">equity<\/a> markets. However, they do face credit risk. This risk arises if the holder of the debt instrument fails to pay for the instrument on maturity. For example, say in a <a href=\"https:\/\/www.tickertape.in\/blog\/alternatives-to-fixed-deposits\/?utm_source=blog&amp;utm_medium=article\">fixed deposit<\/a> scheme, if the financial institution fails to pay back the deposit on maturity, it would be a case of credit risk.<\/p>\n\n\n\n<p>To measure the credit risk of a debt instrument, a credit rating is assigned to them. The higher the credit rating, the safer the instrument is considered to be. Safer instruments are in demand in the market and can be easily traded.<\/p>\n\n\n\n<p>However, if the credit rating of the instrument falls, the credit risk increases. When this happens, such downgraded instruments become unattractive from the trading point of view. Fund managers can sell off such instruments from the portfolio. However, this would result in surplus funds and also reduce the NAV, thereby giving negative returns to investors. Alternatively, fund managers can transfer such downgraded assets to another portfolio, thereby stabilizing the NAV. This is how side pocketing works.<\/p>\n\n\n\n<p>Existing investors continue to hold onto the units of the schemes that have been side-pocketed. Fund managers can restrict the redemption of such units up to a specified period if they predict the credit rating to increase at a later stage. New investors, however, do not get exposure to the side pocketed portfolio, usually. Later on, if the rating of the securities rises back, the existing investors can get the benefit of such an increase and enjoy good returns for holding onto their units for the long term. <\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"benefits\"><span class=\"ez-toc-section\" id=\"Benefits-of-side-pocketing\"><\/span><strong>Benefits of side pocketing<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Side pocketing has major advantages, which is why it is resorted to by many fund managers. Below we discuss some advantages.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"1-Fair-for-investors\"><\/span><strong>1. Fair for investors<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>When the rating of instruments is degraded, existing investors face a reduction in their returns as the NAV of the fund is affected. New investors in the scheme, however, do not feel the pinch since they did not invest in the instrument in its prime days. If the rating bounces back and the value of the portfolio improves, new investors also get the benefit of the improved NAV. This is unfair for existing investors who bore the brunt of the degradation that new investors did not have to. Side pocketing removes this disparity. It holds the downgraded assets in a separate fund, not accessible by new investors. Any rating upgrade, later on can be enjoyed only by the existing investors who stayed invested.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"2-Stability\"><\/span>2. <strong>Stability<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>By transferring the riskier assets to another portfolio, fund managers can stabilize the overall NAV of the portfolio. Since the assets are frozen, the disruption to the portfolio is minimized.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"3-Protects-liquidity\"><\/span>3. <strong>Protects liquidity<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>In the case of redemption, fund managers can sell off the liquid assets of the scheme to meet the redemption pressure. This maintains the liquidity of the fund from being choked by downgraded assets.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"drawbacks\"><span class=\"ez-toc-section\" id=\"Drawbacks-of-side-pocketing\"><\/span><strong>Drawbacks of side pocketing<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Side pocketing also has its limitations that you should know about. These include the following:<\/p>\n\n\n\n<ul><li>Side pocketing does not guarantee recovery. If the rating does not recover, existing investors would ultimately lose out on their investment.<\/li><li>The fund manager might not have the desired experience or the right strategy to create suitable side pockets.<\/li><li>It might create a negative view of the AMC if the investors are not on the same page with the AMC\u2019s decision to create a side pocket.<\/li><\/ul>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"side\"><span class=\"ez-toc-section\" id=\"Side-pocketing-%E2%80%93-important-things-to-know\"><\/span><strong>Side pocketing &#8211; important things to know<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Side pocketing is not mandatory. Though <a href=\"https:\/\/www.tickertape.in\/blog\/securities-and-exchange-board-of-india-functions-powers-and-regulations-of-sebi\/?utm_source=blog&amp;utm_medium=article\">SEBI<\/a> has allowed AMCs to resort to side pocketing, it is completely at the discretion of the fund manager. If the fund manager chooses to opt for side pocketing, investors are duly informed about the same. You might also receive an exit window within which you can exit from the scheme if you do not want to hold onto the instruments which are being allocated to the side pocket.<\/p>\n\n\n\n<p>Side pocketing is gaining traction with changing economic conditions as debt instruments are suffering a credit downgrade across the globe as an after-effect of the COVID-19 pandemic. Understand what side pocketing is all about and how it works, especially if you own a debt mutual fund. This would help you decide whether to hold onto the portion of the fund that is being side pocketed or exit from it.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Want to understand what is side pocketing in mutual funds and how it works? Click here for complete information on side pocketing with meaning, how it works, examples and more.<\/p>\n","protected":false},"author":45,"featured_media":3463,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"_lmt_disableupdate":"","_lmt_disable":"","footnotes":""},"categories":[8,1750],"tags":[440],"acf":[],"modified_by":"Manonmayi","jetpack_featured_media_url":"https:\/\/www.tickertape.in\/blog\/wp-content\/uploads\/2021\/07\/MF-2-3.png?wsr","_links":{"self":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/3460"}],"collection":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/users\/45"}],"replies":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/comments?post=3460"}],"version-history":[{"count":4,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/3460\/revisions"}],"predecessor-version":[{"id":4323,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/3460\/revisions\/4323"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/media\/3463"}],"wp:attachment":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/media?parent=3460"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/categories?post=3460"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/tags?post=3460"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}