Kolkata, Dec 20 (IANS): In order to safeguard investors' interests, the Securities Exchange Board of India (SEBI) will issue a circular on terms and conditions for mutual funds to segregate their distressed debt assets, an official said on Thursday.

"There are bad assets which should be separated so that there is less redemption pressure. This is for the interest of retail investors. It has already been agreed in principle that they (Mutual Funds) should be allowed to create that.

"A circular would be issued soon on what should be the terms and conditions to safeguard the interest of investors," Sebi Chairman Ajay Tyagi said here.

Creation of Segregated Portfolio is a mechanism to separate distressed, illiquid assets from other more liquid assets in a mutual fund portfolio to deal with a situation arising due to a credit event. The mechanism is termed as "side pocketing".

The market regulator's board had in its recent meeting noted the proposal to allow mutual funds to create segregated portfolios with respect to debt and money market instruments subject to various safeguards.

This facility will be available to mutual funds based on credit events. Creating segregated portfolio may be optional for mutual funds, but approval of trustees is necessary for activating such a portfolio.

"With a segregated portfolio, investors who may take the hit when the credit event happens shall get the upside of future recovery, if any. The board also took note of the proposal to review the valuation norms applicable to mutual fund schemes investing in debts and money market instruments," a recent statement had said.