A side pocket is a segregated account within a fund holding illiquid or hard-to-value positions apart from the main portfolio. Investors own their share of the side pocket as of its creation and cannot redeem it — exits from the main fund pay out normally, while side-pocketed value returns only when its assets are actually realized.
How side pockets work and why they're watched
The design solves a fairness problem in open-end structures: if a hedge fund holds positions that can’t be sold or reliably marked (a private stake, defaulted claims, suspended securities), letting investors redeem at the fund’s NAV either shortchanges leavers (marks too low) or lets them exit at values remainers can’t realize (marks too high). Side-pocketing freezes that exposure: the position moves to the pocket at creation, each investor’s pro-rata share attaches to whoever held it then, subsequent subscribers don’t participate, redemptions apply only to the liquid remainder, and fee treatment is typically adjusted (performance fees on side-pocketed assets deferred until realization). The mechanism earned its ambivalent reputation in 2008, when side pockets proliferated — legitimately quarantining genuinely frozen assets, and less legitimately warehousing losses away from redemption-triggering marks. The reading list when a fund uses (or reserves the right to use) side pockets: the governing documents’ limits on pocket size (often capped as a portfolio percentage), valuation and fee treatment inside the pocket, the manager’s track record of actually realizing pocketed assets rather than letting them age, and — for anyone subscribing — whether existing pockets mean the advertised track record includes assets new money won’t own. Side pockets sit alongside gates and suspensions in the liquidity-machinery toolkit: the fine print that defines what “quarterly liquidity” means when it’s tested.
Related terms
Gate Provision · Hedge Fund · NAV · Lock-Up Period · Distressed Debt
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