Definition Definition

What Is a Side Pocket? Understanding Side Pocket with Practical Example

What is a Side Pocket?

In hedge funds, a Side Pocket is a sort of portfolio used to separate risky or low liquidity assets from much more liquid ones. Only the existing hedge fund participants were purposively authorized to a portion of a holding if it reaches a side pocket portfolio. If the asset's profits are recognized, future shareholders will not get a part of the money.

Understanding Side Pocket

In the hedge fund industry, side pocket funds have a lengthy history. Although they are legal and trustworthy financial accounts, regulatory agencies keep a close eye on them. However, for investors, these account holders and their activities must be clearly recorded. Hedge fund managers are also scrutinized for properly valuing these assets to produce reasonable management remuneration.

Side pocket accounts, which are structured similarly to single-asset venture capital firms, are only utilized by hedge fund managers in the hedge fund business. Their goal is to distinguish illiquid, difficult-to-value, and generally high-risk commodities from more financial cash. For example, investments like property investment, heirlooms, over-the-counter (OTC) stocks, stocks with deficient trading activities taken off the market from exchanges, and private equity funds are among the risky investments in these side pocket accounts. 

Aside from being documented on a fund's books, the securities of a side pocket bank statement are managed independently. The investment brochure for the fund includes their bookkeeping and evaluation processes. For example, a shareholder in the fund gets a pro-rata deposit in the side pocket account whenever a side pocket account is opened.

Practical Example

Assume, a fund program has a capital of $100 million, with an equity investment of $5 million owed by a corporation defaulting on its instruments. The fund manager decides to refund the entire investment portfolio when this happens.

Fund managers are forced to sell cash reserves to investment firms as part of the withdrawal process, which impacts ordinary investors. For example, the money manager will carry out side pocketing, separating $5 million from the remaining $95 million in capital. Shareholders will be given units underneath a new allocation depending on this.

In Sentences

  • The term side pocket is commonly used to make a diversified portfolio to manage risky investments. 


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