Many debt funds have underperformed in the recent past and some have even bifurcated their portfolios. How does this work?
The bifurcation of the portfolio you are referring to is known as the segregation of portfolios. The way it works is this - if a fund has a NAV of Rs 100, of which Rs 5 was invested in a security of a company which has defaulted or its rating has been downgraded, etc, then the fund house can resort to creating a side pocket containing the bad bonds. In such a case, the NAV of the main fund takes a hit and reduces by the amount side pocketed. Now, in the future, there's a possibility that this money will be recovered. By segregating the bad bonds, investors' interest stays protected because if the bad debt recovers, investors would be the beneficiary. Further, one can redeem and walk out with the remaining money from the main fund.
This side-pocketing provision ensures that the rightful owner remains entitled to the benefits of the recovery in a fund and gets it in the future, subject to realisation.