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

Investing in many mutual funds allows investors to create diverse portfolios. However, portfolio overlap is a problem you should discuss when investing. This problem occurs when an investor's portfolio contains many funds that hold comparable equities or assets, thus resulting in concentration rather than diversification. Understanding portfolio overlap, its consequences, and techniques to reduce it is essential for maximizing the advantages of diversity while minimizing risks in a mutual fund portfolio. 

What is mutual fund portfolio overlap? 

The under portfolios of mutual fund schemes you invest in could overlap with other schemes within the same category or subcategory. Furthermore, it encompasses the individual stocks within the mutual fund's portfolio and their overall composition or weight. 

It makes sense that you, as the investor, should assess the possibility of adding another one. For instance, if you own many schemes in the same category, such as large mutual funds, they may use comparable techniques or have invested in comparable equities.  

Large-cap funds mandate that the first 100 securities be invested in full market capitalization. Therefore, some underlying securities may be shared by all large-cap funds. It is important that you evaluate whether the portfolio composition of the scheme you are considering is distinct or if it could lead to portfolio overlap and be of limited benefit. 

Things you should note

Remember that adding another mutual fund scheme defeats the goal of diversity when two or more schemes from the corresponding category and subcategory have identical securities held in almost equal weights. After a certain point, every plan you add to your investment portfolio doesn't give you any more benefits and doesn't always reduce risk. It could even generate overlap, take up space in the portfolio, and make managing it more difficult. 

Only schemes with distinctive investment mandates through their style and approach can be added. Do not incorporate a new scheme into your investing portfolio because of a New Fund Offer (NFO) or because the corresponding mutual fund category and subcategory have produced greater returns. 

What you should assess

Before adding any scheme, it’s good to evaluate your risk tolerance, investing target, the financial goals you are addressing, and the amount of time left to accomplish those goals to determine whether adding would be advantageous. It is not advisable to base investing decisions solely on past returns, as they are not representative of the future.  

If you add too many mutual fund schemes, managing your investing portfolio over time would be challenging. Your portfolio may include schemes with overlapping investments and underperforming schemes.   

How do you check and avoid portfolio overlap? 

You can use various online tools to determine whether the portfolios of two or more mutual fund schemes overlap. To check, simply choose the category and subcategory and enter the schemes' names there. 

With the online mutual fund portfolio overall tools, you can view the number of common stocks, the proportion of portfolio overlap, the rare stocks in Fund A and Fund B, and more. 

Ideally, funds from the relevant category and subcategory should be compared when utilizing the portfolio overlap online tool to ensure a reasonable comparison.  

As you can see, there will always be some overlap in your portfolio; this is acceptable. However, concentration risk may arise if it is very high, say 65% or above. The risk-return characteristics of two mutual fund schemes with substantial portfolio overlap may be comparable. 

Moreover, the overlap between mutual fund portfolios is dynamic. This means that it will adjust in tandem with whatever modifications the fund manager makes to the underlying portfolio.  

This will help you verify that your investments overlap and evaluate the performance and overall health of your portfolio.  

Final thoughts 

In short, investors should be aware of controlling portfolio overlap while using mutual funds. Reducing redundancy promotes stability, maximizes resources, and guarantees openness in investment choices. Addressing portfolio overlap is essential for stimulating financial situations and navigating the mutual fund investing market.