Mutual Fund Portfolio Overlap: What It Is and How To Avoid It

When planning investments, a common piece of advice is to “diversify” your portfolio.  A well-diversified portfolio helps mitigate potential risks and provides greater stability. Many investors turn to mutual funds for this purpose, as mutual fund companies pool money from several investors and invest it into a variety of securities and stocks on their behalf.

However, simply investing in multiple mutual funds does not necessarily guarantee the diversification you seek. An often overlooked but important factor is “mutual fund portfolio overlap,” which can actually reduce diversification and increase risk. This article will explain mutual fund overlap, how it impacts your portfolio, and how you can avoid it.

What is mutual fund overlap?

Mutual fund overlap occurs when multiple schemes invest in the same or similar securities. If an investor chooses to invest in two separate mutual funds that hold the same companies, this creates overlap. This means, if one fund experiences a decline in value, the other likely will, too, leading to greater potential losses for the investor.

Several factors can cause overlap. A significant reason for overlap in mutual funds is the regulatory guidelines mandated by SEBI. These regulations define specific categories in which a fund can invest. For instance, large-cap funds must invest at least 80% in the top 100 stocks based on market size.

What are the effects of mutual fund overlap?

Here's how mutual fund overlap can affect your investment portfolio:

- Overlapping investments reduce the overall diversification of the portfolio.

- It can concentrate risk because losses in one security can impact multiple funds that hold it.

- Poor performance of overlapping securities affects multiple funds, potentially lowering your overall investment returns.

- Overlap can lead to higher expenses as investors may pay fees to multiple fund managers who hold similar assets, duplicating costs.

How to avoid mutual fund overlap?

Some strategies to avoid portfolio overlap include:

1. Systematically diversifying across fund categories

Picking categories with minimal overlap in their mandates can significantly reduce risk. For example, investing in two or three large-cap funds would not be optimal diversification, as they all have substantial overlap. Instead, investing in large-cap, mid-cap, and small-cap funds would minimise this overlap.

2. Investing across multiple AMCs

AMCs often have distinct investment styles. This is why investing in multiple funds from the same AMC can lead to considerable overlap. Choosing to spread your investments across different AMCs helps ensure different investment philosophies, stock selection strategies, and minimal overlap.

3. Regular portfolio assessment

Fund portfolios are susceptible to change and thus require periodic monitoring. Reviewing your portfolio overlap before investing and regularly checking it helps maintain diversification.

To end

While it’s impossible to eliminate all overlap in your mutual fund investments, employing diversification strategies can certainly reduce risk. The first step in this process is to identify potential overlaps by analysing fund holdings, utilising specific portfolio analysis tools, or consulting with investment professionals.