Side Pocket

A side pocket separates assets that are illiquid, hard to value or subject to special circumstances from the fund’s main portfolio. Investors at the time an asset is designated receive side-pocket interests pro rata to their holdings. New investors do not participate in existing side pockets, and existing investors cannot usually redeem their side-pocket interests until the asset is realized.

Side pockets protect fairness. Without them, redeeming investors could exit at a value that does not reflect what the illiquid asset will eventually realize, and new investors could buy into an asset whose value is uncertain. The offering documents usually set limits on side-pocket size and govern how management fees and performance fees apply.

Pitfalls include inconsistent valuation methods for side-pocket assets, fee charges that are not permitted by the documents, poor record-keeping of which investors participate, and complex allocations when a side-pocket asset is partially realized.

Example

A $200M fund designates a $10M private holding as a side pocket. An investor holding 5% of the fund at designation receives $500,000 of side-pocket interests and keeps a 5% stake in the remaining $190M liquid portfolio.