If an issuer of a bond held in the portfolio of a mutual fund scheme fails to pay the interest or the principle on time or sees a downgrade to below investment grade, then the NAV of scheme drops. Then, the fund house carves out this infected portion, into a segregated portfolio.

This is done to avoid a run on the scheme and to protect the unit holders. Otherwise, savvy investors could enter the fund when it is down and profit from the (sharp) upside on recovery. Redemption in units of segregated portfolio are not allowed, however they are listed. The fund house cannot charge asset management fee on this.