The Use of Side Pockets by CISs

The MFSA has issued a guidance note on the use of Side Pockets by collective investment schemes. The guidance note applies to professional investor funds (PIFs) which are in the process of being established and which contemplate the use of Side Pockets in their offering memorandum when and if such need arises. Side Pockets are devices used by some funds (ordinarily hedge funds), as a means of addressing issues arising where certain assets within the fund’s portfolio become illiquid or comparatively hard to value. Where an asset is illiquid, this may affect the ability of the fund to realise the asset (or realise the asset at a reasonable price) in order to meet redemption obligations. Where an asset cannot be valued accurately, the risk arises that prices for any subscriptions and redemptions in respect of the relevant portfolio of the fund will not accurately reflect the fair value of the relevant asset with the resulting concentrative and dilutive effects for investors.

The creation of a side pocket normally involves the designation of an asset as illiquid or hard to value and the transfer of that asset into a specially created new class (or Side Pocket) within the fund. Thus illiquid or comparatively hard to value assets are separated from the main pool of more liquid investments allowing continued issue and redemption of Units in the liquid pool while reducing the risks mentioned above. The guidance note can be accessed from the MFSA website.