Side pocketing is a mechanism used by mutual funds to segregate distressed, downgraded, or defaulted securities from the rest of the healthy portfolio. When a debt security held by a mutual fund faces a credit event — such as a sharp downgrade by a credit rating agency or outright default — the value of the mutual fund’s NAV (Net Asset Value) may drop drastically. This situation can create panic among investors, prompting them to redeem units and exit the fund, often at the expense of long-term investors who stay invested. To prevent this unfairness, side pocketing was introduced as a solution. It essentially “carves out” the troubled asset and keeps it in a separate portfolio. Investors who were already in the scheme at the time of the credit event continue to hold units in both.