Investing in mutual funds is the most widely used method of progressively increasing wealth. Due to the multiple options, investors usually diversify their portfolios by purchasing a variety of mutual funds. Additionally, “Diversification” is one of the primary benefits of investing in mutual funds. But did you know that investing in many funds doesn’t typically lead to higher profits? The concept of mutual fund portfolio overlap enters the picture at this point.
What is Mutual Fund Portfolio Overlap?
When two or more mutual funds have sizable holdings in the same companies or securities, this is known as portfolio overlap. Your portfolio is not as diverse as you may believe, for instance, if you invest in two distinct stock mutual funds and both funds own sizable shares of Company A.
For instance:
Suppose you invest in two different funds i.e., “A” mutual fund scheme and “B” mutual fund scheme.
Following are the top 5 holdings of each scheme –
| A Scheme | Weightage (%) | B Scheme | Weightage (%) |
| Larsen & Toubro | 5% | Bajaj Finance | 5% |
| Bajaj Finance | 6% | TCS | 3% |
| TCS | 4% | SBI | 4% |
| SBI | 2% | HDFC Bank | 2% |
| ICICI Bank | 4% | Eicher Motors | 3% |
We can see that TCS, SBI & Eicher Motors have common holdings from the above analysis. Hence, the mutual fund portfolio overlaps. Additionally, there is a risk that two mutual funds, which are in a similar category from separate AMCs may have similar portfolio holdings.
Understand mutual fund portfolio overlap with an example
Imagine an investor who puts money into two different funds: Fund A, which is a large-cap fund, and Fund B, a blue-chip fund. At first, the investor might think they are diversifying their investments because these funds have different names and strategies. However, when they check the stocks held by each fund, they discover stock overlap—both funds own some of the same companies.
For instance:
Fund A has 8% of its investments in Reliance Industries, while Fund B has 10% in the same company.
Additionally, both funds invest in HDFC Bank, with Fund A having 7% and Fund B having 6% allocated to it.
This means that even though the two funds are different, they share some common stocks.
Having stock overlap can lead to overexposure in certain sectors or companies. If those companies do poorly, it can significantly affect your overall returns, even if you believe you have diversified your portfolio by investing in multiple funds. Therefore, it’s essential to be aware of stock overlap when managing mutual fund investments to ensure true diversification.
Why Does Portfolio Overlap Happen?
- Similar Investment Strategies: Funds with comparable objectives, such as growth-oriented or large-cap funds, sometimes end up purchasing the same collection of top-performing equities. ‘
- Benchmark Tracking: There is overlap since several funds follow similar benchmarks, such as the Sensex or NIFTY 50.
- Blue-Chip/Large Company Stocks: Many Mutual fund managers frequently pick certain stocks because they are regarded as safe investments and have the potential to deliver stable returns.
Why Should You Care About Portfolio Overlap?
- Lower Diversification: Diversification’s main objective is to lower risk. This benefit is diminished when stocks overlap.
- Concentration Risk: If a large portion of your funds is invested in the same stocks, a drop in those stocks could significantly impact your overall portfolio.
- Duplicate Costs: Funds that effectively invest in the same assets may result in higher costs.
How to Check for Portfolio Overlap?
- Make use of websites and tools made especially for comparing mutual fund portfolios.
- To see their top holdings, view the fund factsheets.
- Keep an eye out for stock-level investments and sector overlaps.
Websites to check Portfolio Overlap.
- primeinvestor.in
- advisorkhoj.com
- investyadnya.in
Tools to Measure Mutual Fund Overlap
An online Mutual Fund Overlap tool helps you easily find out how much your mutual funds overlap. To use it, simply select the type of funds and the specific schemes you want to compare, then click “calculate.” The tool will show you the overlap percentage, the common securities, and how much of your investment is allocated to those overlapping stocks.
Different tools have different features. Some allow you to compare two mutual funds, while others can handle up to four. Two popular options for this are Morningstar PM and Value Research, but be aware that you might need a subscription to access detailed results about overlapping securities and their weights.
Strategies to Reduce Mutual Fund Overlap
To minimize mutual fund overlap in your investment portfolio, you can follow several practical strategies. While it’s tough to eliminate overlap, especially since many funds invest in popular stocks, you can take steps to reduce it. Here’s how:
Diversify Across Different Fund Categories: Invest in various types of mutual funds, such as small-cap, mid-cap, and sector-specific funds. This approach helps reduce overlap because different categories often invest in different stocks.
Invest in Different Fund Houses: Each asset management company (AMC) has its own investment strategy, which can lead to different stock selections. By spreading your investments across multiple fund houses, you can further minimize the chances of overlap.
Check Fund Holdings Before Investing: Always look at the list of stocks held by a fund before you invest. This information is usually available on financial apps or in fund fact sheets. Since fund portfolios can change frequently, it’s wise to review them regularly and adjust your investments as needed.
Consult an Investment Advisor: A financial advisor can help assess your overall financial situation and create a balanced portfolio that avoids overexposure to any particular stock or sector.
By implementing these strategies, you can work towards a more diversified mutual fund portfolio and reduce the risks associated with having too much overlap in your investments.
How Can You Reduce Portfolio Overlap?
- Diversify your investments among different fund categories: Invest in mutual funds that follow different investment strategies, such as growth, and value, and different categories such as large-cap, small-cap, and mid-cap funds. Avoid investing in more than one fund in the same category.
- Look Past Well-Known Funds: In certain cases, less well-known funds provide superior diversity.
- Consistently Check Your Investments: Make sure your investments are in line with your financial objectives by regularly reviewing them.
Conclusion
While mutual funds are an excellent tool for wealth creation, it’s essential to dig deeper into where your money is being invested. Understanding and minimizing portfolio overlap ensures your investments are genuinely diversified, reducing risk and maximizing potential returns. Make informed choices, stay vigilant, and let your money work smarter for you!