Segregated Portfolios (Side Pockets) — NAV, Fees and Units
A segregated portfolio, often called a side pocket, lets a scheme separate a debt security hit by a credit event from the rest of its portfolio. This lesson explains when it can be created, who gets its units, how the two NAVs work and what may be charged on it.
The problem it addresses
When a bond held by a scheme is downgraded to below investment grade or defaults, what it will finally be worth becomes uncertain. If it stays in the main portfolio, anything recovered later is shared by whoever holds units at that time, including investors who joined after the event and bore none of the fall.
A segregated portfolio separates the debt or money market security hit by the credit event from the rest of the scheme's portfolio, so that the outcome on that security stays with the investors who held units when the event happened.
When it can be created
The trigger is a credit event: a downgrade of the issuer to below investment grade, meaning below BBB−, or, for unrated paper, an actual default.
A segregated portfolio is optional. It can be created only if the Scheme Information Document provides for it and the trustees approve it. It is not automatic, and it does not need a vote of unitholders.
Units and NAV after segregation
Every unitholder on the day of the credit event receives the same number of units in the segregated portfolio as they hold in the main portfolio. No investor is left out or preferred. The main portfolio and the segregated portfolio then each have their own NAV.
Investors who buy after the segregation get units only in the main portfolio and have no claim on anything recovered from the segregated security. Units of the segregated portfolio are listed on a stock exchange within 10 business days.
Fees and recovery
No investment-management fee is charged on the segregated portfolio. The fund house therefore earns no management fee on a security that has suffered a credit event while unitholders wait to see what is recovered.
Any recovery goes to the holders of the segregated units. Recovery is not assured: it may be full, partial or nothing.
Rules at a glance
Who shares in a recovery (illustrative)
Suresh held units of a debt scheme on the day of a credit event. Tara bought units a month later. Suresh now has units in both the main portfolio and the segregated portfolio; Tara has units only in the main portfolio.
If the issuer later repays part of the money, it goes to holders of segregated units such as Suresh. Tara has no claim on it. Equally, the fall in that security was never in the NAV she paid, which was the NAV of the main portfolio alone.
One NAV becomes two (assumed figures)
- Assume a debt scheme has 5 crore units and net assets of ₹100 crore, an NAV of ₹20.00. One bond, carried at ₹4 crore, is downgraded to below investment grade.
- Assume the bond is now valued at half its earlier value: ₹4 crore × 50% = ₹2 crore.
- The trustees approve a segregated portfolio. Main portfolio = ₹100 crore − ₹4 crore = ₹96 crore, so its NAV = ₹96 crore ÷ 5 crore = ₹19.20.
- Segregated portfolio = ₹2 crore. Unitholders receive 5 crore units in it, one for each unit held, so its NAV = ₹2 crore ÷ 5 crore = ₹0.40.
- An investor with 1,000 units holds 1,000 × ₹19.20 = ₹19,200 in the main portfolio and 1,000 × ₹0.40 = ₹400 in the segregated portfolio: ₹19,600 in all, against ₹20,000 before.
Result. The ₹400 fall is the investor's share of the markdown. If the full ₹4 crore is later recovered, each segregated unit is worth ₹4 crore ÷ 5 crore = ₹0.80, or ₹800 on 1,000 units; if nothing is recovered, the segregated units are worth nothing.
Key points
- A segregated portfolio (side pocket) separates a security hit by a credit event from the rest of a scheme's portfolio.
- A credit event is a downgrade to below investment grade (below BBB−) or a default.
- It is optional: the Scheme Information Document must provide for it and the trustees must approve it.
- Unitholders on the day of the credit event get the same number of units in the segregated portfolio as they hold in the main portfolio.
- The two portfolios have separate NAVs, and investors who buy later get units only in the main portfolio.
- Segregated units are listed on a stock exchange within 10 business days.
- No investment-management fee is charged on the segregated portfolio, and recovery is not assured.
Common misunderstandings
- A segregated portfolio is not automatic on a downgrade: it is optional and needs a provision in the Scheme Information Document and trustee approval.
- It is not a promise of recovery: the segregated security may pay back in full, in part or not at all.
- New investors do not get segregated units: only those who were unitholders on the day of the credit event do.
Questions people ask
What counts as a credit event?
A downgrade of the issuer to below investment grade, that is below BBB−, or, for unrated paper, an actual default.
How many segregated units does an existing investor receive?
The same number as the units held in the main portfolio on the day of the credit event.
Does the fund house earn a management fee on the segregated portfolio?
No. No investment-management fee is charged on it.
What this lesson relies on
- SEBI Master Circular for Mutual Funds (20 March 2026) — provisions on creation of segregated portfolios in mutual fund schemes
This lesson was reviewed independently against these sources on 8 October 2026. Rules change: check the current regulation, scheme document or policy wording before relying on any figure. This is education, not advice.