Sebi was in talks with industry to allay fears of contagion effect on mutual funds.Mutual funds can separate distressed and illiquid assets in their portfolios to deal with any potential credit crisis, the market regulator said on Wednesday.The Securities and Exchange Board of India (SEBI) was in talks with the industry to allay fears of contagion effect on mutual funds due to a liquidity crisis faced by the country's non-banking finance companies (NBFCs), its chief had said last week.NBFCs were hit by a credit crunch in September and October after Infrastructure Leasing and Financial Services (ILFS) defaulted on a series of debt obligations spreading panic among other NBFCs."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 regulator said in a statement.Mutual funds are heavily invested in papers issued by the so-called shadow banks, and, analysts say, a potential default at these banks could cripple many of these funds."It will help MFs (mutual funds) deal with the problem of defaults and help schemes function better, especially when one paper defaults," said the fixed-income head of a mid-sized mutual fund house, who declined to be named as it is a regulatory issue."It also gives clarity to investors who are at a loss during event such as ILFS, and will boost their confidence in debt funds".The regulator also approved a proposal to allow clubbing of investment limit for foreign portfolio investment on the basis of common ownership of more than 50 percent or common control.However, in the case of properly regulated public retail funds, investment limits will not be clubbed on the basis of common control, SEBI said.The regulator also widened the scope of the existing offer-for-sale mechanism by making the offer available for shareholders of companies with market value of 10 billion rupees ($139.08 million) and above.