The Securities and Exchange Board of India (SEBI) on Friday clarified in a circular that in cases where the instrument held by a debt fund goes below the "investment grade" (below BBB rating), fund houses can choose to segregate bad securities (stressed debt securities) so that the investors can continue to buy or sell the good portion of the scheme. Fresh investments will not be allowed on these segregated portfolios.

Also known as side pocketing, this method ensures that money invested in a liquid mutual fund scheme will now be divided into two parts. One that will be the linked to all the stressed assets that can remain locked (frozen) until the fund has recovered the cash from the company and the investor can redeem from the good part of the fund in the meantime.

SEBI has given the fund manager the discretion on whether or not they wish to use the facility. The fund houses will however not be able to do it immediately and will first need to mention it in their Scheme Information Documents (SID).

Ever since the Infrastructure Leasing & Financial Services Ltd (IL&FS) crisis that broke out in August 2018, there has been a debate on whether or not the mutual fund houses should be allowed an option to side pocket investments.