Mutual fund investor? This big move by regulator Sebi impacts you. All about ‘side pocketing’

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Updated: December 14, 2018 3:23:10 PM

After capital market regulator SEBI allowed side-pocketing in mutual funds, experts say that segregation of illiquid and troubled assets will benefit the investors, and ensure that the funds do not face undue redemption pressures due to the stressed asset. We take a closer look.

Side pocketing will allow the fund houses to isolate risky assets from the rest of their holdings and cap redemption.

After capital market regulator SEBI allowed side-pocketing in mutual funds, experts say that segregation of illiquid and troubled assets will benefit the investors, and ensure that the funds do not face undue redemption pressures due to the stressed asset. Notably, the latest regulation will allow the fund houses to isolate risky assets from the rest of their holdings and cap redemption.“This side pocketing ensures that there is a clear separation of liquid and illiquid assets. Accordingly, side pocketed assets are not allowed for subscription or redemption.” Basavaraj Tonagatti, a SEBI-registered  Investment Adviser said in a note to FE Online. We take a closer look.

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How it works

Explaining the modalities of the new regulation, Harshvardhan Roongta, CFP, Roongta Securities said that side pocketing of mutual funds will allow the fund houses to segregate the troubled assets from the rest of their good holdings and also place a cap on further subscription into the troubled asset. Once the troubled security is segregated, the existing MF scheme investors will be provided with two NAVs– one for the scheme with the troubled security, and one with the collection of good securities, Roongta said, adding that the segregated portion with the bad investment gets closed for subscriptions as well as redemptions for new and existing investors.

“The ‘good’ portion of the scheme will be open for subscription and redemption, and will continue as usual,” he pointed out. Basavaraj Tonagatti said that this segregation protects investors from a sharp fall in NAV. “However, how the NAVs will be arrived at from the stressed or illiquid asset is a matter of concern,” he added.  The scheme can be thought of as a demerger, wherein the troubled unit is demerged from the bigger unit, Roongta explained. This will ease redemption pressure in mutual funds in case the fund has invested into an illiquid security, as a security gets downgraded.

The benefits

Explaining the benefits for retail investors, Harsh Roongta said that this change ensures that funds do not face undue redemption pressures and a sudden drop in NAV. “In case of no segregation, the liquid securities had to be sold off in order to meet redemptions from investors. It was not benefitting anybody, neither the scheme, nor the investors,” he noted.  Basavaraj explained that the main motive behind the regulation was to protect investor’s returns generated from liquid or non stressed assets. Further, in a panic situation, investors need not worry about the liquidity issue or sudden fall in NAV, he added.

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