How to Find & Avoid Mutual Fund Portfolio Overlap?
Have you ever wondered what happens when you invest in multiple mutual funds, and they hold the same stocks? This is what we call ‘mutual fund overlap’. Knowing about mutual fund overlap can help you understand your investments better and manage risks more effectively. By being aware of how mutual fund overlap works, you may identify potential redundancies in your portfolio and make more informed choices. This article will explore mutual fund portfolio overlap’s meaning, factors, causes, and effects.
What is Mutual Fund Portfolio Overlap?
Mutual funds invest in securities like stocks and bonds for their clients. Equity funds focus on stocks and often invest in the same companies. Although you might think you have diversified by investing in various equity funds, your money might be in the same stocks. Portfolio overlap in mutual funds measures how similar the holdings are across multiple funds in an investor’s portfolio. This overlap happens when different funds hold many of the same stocks or assets.
While diversifying across numerous funds is meant to spread risk, too much overlap can instead concentrate risk. High portfolio overlap can lead to inadequate diversification, increasing exposure to specific sectors, industries, or securities. When multiple funds hold the same stocks, the portfolio is more vulnerable to market fluctuations or adverse events, affecting overall performance.
To manage these risks, investors should assess portfolio overlap by analysing their funds’ holdings and identifying common stocks or sectors. Managing mutual fund portfolio overlap is crucial for optimising diversification benefits and minimising concentration risks, thereby enhancing overall portfolio performance.
What are the Causes of Mutual Fund Overlap?
Let’s have a look at the causes of overlap in mutual fund portfolios:
- SEBI’s Category-Wise Mandate: Before 2018, funds lacked specific category investment guidelines, leading to inconsistencies. For example, some funds labelled as large-cap would also invest in small-cap stocks. In 2018, SEBI standardised fund categories to ensure consistency and prevent surprises for investors. Large-cap funds now must invest at least 80% of their assets in the top 100 stocks by market size. This restriction increases the likelihood of different funds selecting the same stocks, raising the possibility of a portfolio overlap.
The overlap is more pronounced in categories with smaller universes. Large-cap funds have a limited pool of 100 stocks, leading to higher overlap. In contrast, mid-cap and small-cap funds have broader universes. Mid-cap funds invest at least 65% in the 150 stocks after the top 100, giving them a larger pool. Small-cap funds invest at least 65% in stocks beyond the top 250, with a virtually limitless selection from over 5,000 listed stocks. By comparing the portfolio overlap between the top funds in each category, we can see that tighter investment universes lead to higher overlap.
- AMC-Specific Investment Style: Portfolio overlaps can occur when all your funds are from the same asset management company. This happens due to the AMCs’ specific investment styles. Each AMC has a unique philosophy and method for selecting investments. Fund managers often have biases that influence their stock-picking strategies. As a result, funds from different categories might include common stocks or stocks from the same sectors.
- Market Trends: Sometimes, certain types of investments or specific sectors become popular in the stock market. As a result, many portfolios include these popular investments, which may cause a fund portfolio overlap. For example, green and renewable energy stocks are currently popular among investors interested in renewable energy solutions, and thus, multiple portfolios may include them.
- Building a Portfolio Aligned with Market Index: Individuals frequently refer to market indexes like the Sensex or Nifty 50 when constructing their investment portfolios. Numerous index funds and ETFs are designed to mirror these indices. However, investing in multiple index funds and ETFs that all track the same index can result in MF overlap for investors.
Effects of Mutual Fund Overlap
Here are a few effects of excessive mutual fund portfolio overlap:
- Reduced Diversification: Investing in multiple mutual funds is meant to diversify your portfolio. However, this diversification is compromised if these funds share many of the same holdings.
- Concentration of Risk: When mutual funds overlap, the risk becomes concentrated. Losses in one security can impact multiple funds, increasing overall risk. This happens when there is a higher percentage of overlap and a correlation of fund performances.
- Lower Potential Returns: Poor-performing stocks can have a greater negative impact across overlapping mutual funds, reducing potential returns.
- Increased Costs: Overlap can lead to higher expenses for investors. They may incur fees from multiple fund managers handling the same assets.
How Can I Reduce Mutual Fund Overlap in My Portfolio?
You can’t eliminate portfolio overlap since some stocks always appear in multiple funds. A good company will naturally attract investment from many funds. Several factors can cause portfolio overlap. An attractive value stock will appear in many value funds, and a fast-growing company will be included in many growth funds. If multiple funds are bullish on a sector or theme, the top stocks in that sector will appear in many funds.
Given that overlap is unavoidable, the key question is how much is acceptable. There’s no strict rule, but a lower overlap is better for diversification. Investors may aim to keep overlap below 33%. Here are a few ways investors may reduce mutual fund overlap in their portfolios:
- Invest in Structured Categories: Investing in different fund categories without a structure can still lead to high overlap. This happens because the investment universe of these categories overlaps. Investors can ensure the categories they pick have distinct mandates.
- Invest Across AMCs: Different AMCs have different investment philosophies and stock-picking frameworks, which can reduce overlap. Investing across AMCs diversifies the investment approach and can potentially reduce portfolio overlap.
- Passive Investments: Passive investments like index funds or ETFs can offer broeder market exposure and lesser chances of overlap.
- Review Portfolio Overlap Periodically: Before investing, check portfolio overlap and review it periodically. Portfolios change over time, so monitoring your funds’ holdings regularly is essential to manage overlap effectively.
Example of a Mutual Fund Portfolio Overlap
Understanding mutual fund overlapping is crucial for making informed investment decisions. Let’s explore a real-time example of a mutual fund portfolio overlap in two bluechip funds: ICICI Prudential Bluechip Fund and SBI Blue Chip Fund.
The current percentage of overlap between these two fund portfolios is 30%. This means that 30% of the portfolios in both funds consist of the same stocks. The two funds have 20 stocks in common. ICICI Prudential Bluechip Fund has 29 uncommon stocks and invests in 49 stocks in total. On the other hand, SBI Blue Chip Fund has 32 uncommon stocks in its portfolio and 51 stocks in total. Here is a table to compare mutual fund overlap between these two funds:
| Common Stocks Present in Both Funds | % Overlap in ICICI Prudential Bluechip Fund | % Overlap in SBI Blue Chip Fund |
| ICICI Bank Ltd | 8.22% | 9.22% |
| HDFC Bank Ltd | 7.72% | 9.66% |
| Bharti Airtel Ltd | 4.70% | 4.52% |
| Infosys Ltd | 2.32% | 3.09% |
| State Bank Of India | 1.93% | 3.49% |
| Kotak Mahindra Bank Ltd | 1.49% | 4.18% |
| Mahindra & Mahindra Ltd | 3.67% | 1.37% |
| Hindustan Aeronautics Ltd | 1.03% | 3.73% |
| Larsen & Toubro Ltd | 3.69% | 0.97% |
| NTPC Ltd | 1.91% | 0.82% |
| Cipla Ltd | 0.70% | 5.08% |
| Apollo Hospitals Enterprise Ltd | 0.62% | 3.32% |
| Maruti Suzuki India Ltd | 0.57% | 2.27% |
| SBI Life Insurance Company Ltd | 0.48% | 3.93% |
| Power Grid Corporation Of India Ltd | 0.45% | 1.76% |
| Reliance Industries Ltd | 6.92% | 0.26% |
| HCL Technologies Ltd | 0.25% | 4.16% |
| Tata Steel Ltd | 0.96% | 0.18% |
| Interglobe Aviation Ltd | 2.20% | 0.08% |
| Net Current Asset | 0.61% | 0.07% |
Challenges of Mutual Fund Portfolio Overlap
Excessive overlap of mutual funds increases risks during market downturns. Investors need varied strategies and asset mixes to achieve true diversification, which can be difficult with overlapping funds.
Is It Possible to Avoid Portfolio Overlap?
While achieving absolute zero mutual fund overlap can be quite challenging, there are strategies you can implement to lessen it significantly. The key lies in diversification. Diversifying means spreading your investments across different kinds of assets—think stocks, bonds, real estate—and various sectors like IT, healthcare, and finance. This approach lowers the chances of having overlaps in your investments.
Furthermore, conducting your own research and exploring less mainstream funds from various categories can uncover unique investment chances. Keeping a close eye on your portfolio and adjusting it when needed – like selling redundant investments and branching into other assets – can also help minimise overlap. By effectively identifying overlapping of mutual funds, investors can make informed decisions, strategically reallocate investments, and achieve a more diversified and balanced portfolio.
How to Identify Mutual Fund Portfolio Overlap?
Investors thoroughly analyse their fund holdings to recognise portfolio overlap within mutual funds. Key steps include:
- Analysing Fund Holdings: Evaluate holdings across different mutual funds for common stocks, securities, or sectors.
- Quantitative Assessment: Use tools like correlation coefficients to measure overlap extent and assess concentration in specific stocks or sectors.
- Examining Fund Reports: Scrutinise detailed reports from mutual funds to identify common positions. Investors can use tools like the Tickertape Mutual Fund Screener to examine mutual funds’ past performance and composition.
- Seeking Expert Consultation: Engage financial advisors for assistance in analysing portfolio overlap and diversifying across fund categories.
Should You Be Concerned About a Mutual Fund Portfolio Overlap?
As an investor, it is important to grasp the concept of mutual fund portfolio overlap and maintain a portfolio overlap check. For instance, index fund investments occasionally result in a high percentage of mutual fund overlap due to shared underlying indexes. A high percentage of portfolio overlap means investing in the same assets again and again, and investors should be aware of that possibility before investing.
Why Diversify Your Mutual Fund Portfolio?
Diversifying your portfolio across different asset classes and sectors maximises returns and reduces risks. This strategy protects against market downsides and controls market volatility by preventing a single underperforming asset from significantly affecting the entire portfolio.
Understanding mutual fund portfolio overlap is crucial for creating a well-diversified investment strategy. Minimising overlap through diversification and thorough research helps investors optimise their portfolios for better risk-adjusted returns.
Benefits of Avoiding Mutual Fund Portfolio Overlap
Reducing MF portfolio overlap offers several advantages that enhance an investor’s financial position and overall portfolio management:
- Minimised concentration risks: Reducing overlap across fund holdings creates a more diversified portfolio, spreading investments across various asset classes, sectors, and industries. This diversification reduces the risk of overexposure to specific stocks or market segments.
- Improved risk-adjusted returns: A portfolio with less overlap achieves a more balanced risk-return profile. Diversification provides steadier growth and better resilience to market volatility, leading to more consistent returns.
- Enhanced portfolio flexibility: Lower overlap gives investors greater control over their portfolio composition, allowing for strategic adjustments in asset allocation. This adaptability helps investors respond to changing market conditions or personal financial goals.
- Optimised resource allocation: A less overlapped portfolio efficiently allocates resources by avoiding duplication and streamlining investment efforts. This optimisation can reduce transaction costs and improve the efficiency of the investment process.
- Long-term stability: Minimising overlap contributes to sustained growth and long-term stability. A well-diversified portfolio provides a foundation for more effectively navigating market fluctuations and uncertainties.
- Diversification of risk: As discussed before, the correlation of fund performances can increase the chances of overexposure to common risk factors. Avoiding overlap in funds can diversify the risk factor as investors will be investing in different assets
- Synergy in portfolio management: Decreasing overlap improves coordination among fund holdings, facilitating a cohesive portfolio strategy that aligns with overall financial objectives and risk tolerance.
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Factors to Consider Along with Mutual Fund Portfolio Overlap
When assessing mutual fund portfolio overlap, consider several key factors for a comprehensive investment strategy.
- Fund Returns: It is important to understand that fund returns depend not only on the overlap but also on the weights of shared and unique stocks within each fund. This weight differentiation can significantly impact performance, especially for overlaps exceeding 80%.
- Risk Metrics: Evaluate risk metrics like standard deviation and the Sharpe ratio to gain insight into a fund’s risk and return volatility. This will help you make informed investment decisions.
- Fund’s Consistency: Paying attention to monthly portfolio changes can help assess a fund’s consistency in outperforming its benchmark and category over time.
- Track Records of the Fund: Consider the track records of the fund manager and the Asset Management Company (AMC), as they play a crucial role in fund management and performance.
To Wrap It Up…
Mutual fund portfolio overlap can potentially hinder the advantages posed by diversification. While it might not be entirely eradicated, investors can proactively try to minimise it. One effective approach is to spread investments across different fund categories and various fund management companies. If you’re a mutual fund investor who wants to explore portfolio diversification options, you can explore smallcase!
Frequently Asked Questions About Mutual Fund Overlap
Mutual fund overlap in a portfolio refers to the number of stocks and their weights commonly held between two funds.
The acceptable amount of overlapping in mutual funds depends on several factors, including investment goals, risk tolerance, and time horizon. There’s no strict rule, but a lower overlap is better for diversification. Investors may aim to keep overlap below 33%.
If two or more mutual funds have a significant number of the same securities in their portfolios, they overlap. You can check mutual fund overlaps on the fund’s website, online portfolio overlap tools or an online financial portal.
Mutual fund overlap can cause concentrated risk. The poor performance of commonly held funds can impact multiple funds adversely. This doubles the risk of incurring losses.
Mutual fund overlap can be calculated by counting the elements (holdings or monetary units when using market capitalisation) common to both portfolios and then dividing by the total number of elements in the portfolios.
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