Mutual Fund Portfolio Overlapping & How to Check: Meaning & Tool

When you invest your hard-earned money in mutual funds or stocks, you need to be made aware of the underlying stocks in the portfolio. And there are chances that your portfolio may have a significant overlap with another mutual fund scheme. This overlap is known as mutual fund portfolio overlap. Understanding mutual fund portfolio overlap is crucial to managing and diversifying your investment portfolio. In this blog post, we'll explain what mutual fund portfolio overlap is, its causes, and how to avoid it.

What is Mutual Fund Portfolio Overlap?

Mutual funds are those investment vehicles that pool money from several investors to invest in a variety of assets such as stocks, bonds, and other securities. When a mutual fund invests in the stock market, it buys shares of different companies based on the investment objective of the fund. These shares of different companies held in a mutual fund's portfolio represent the collective ownership of the fund's investors.

Mutual fund portfolio overlap can occur when two or more mutual fund schemes hold the same stocks in their portfolio. For instance, if Fund A and Fund B both invest in the same company's shares, the portfolios of the two funds would overlap. It is worth noting that some degree of overlap between mutual fund portfolios is common, and it can be intentional, as fund managers may have similar investment strategies or investment objectives.

However, excessive overlap can result in concentrated positions, increased risk, and reduced diversification. Concentrated positions can arise when a mutual fund has a specific holding in a single stock, which can increase the risk of the portfolio if the stock underperforms. Reduced diversification can result from excessive overlap, which can lead to a higher correlation between the stocks held in the portfolios, thereby reducing the benefits of diversification.

In addition to the potential risks of overlap, investors may face additional fees and charges if they invest in multiple mutual funds with excessive overlap. This is because investors are indirectly investing in the same companies through different mutual funds, and they may end up paying multiple management fees and other expenses for investing in the same stocks.

Causes of Mutual Fund Portfolio Overlap

Several factors can cause mutual fund portfolio overlap. Some of the common reasons are:

1. Investment Style: Mutual fund schemes with similar investment objectives and strategies tend to hold similar stocks in their portfolio. For example, if two mutual funds invest in large-cap stocks, there is a high probability that their portfolios will overlap.
2. Industry Concentration: Mutual fund schemes with a significant allocation to a particular sector or industry may have an overlap in their portfolio. For example, if two mutual funds invest heavily in the pharmaceutical sector, their portfolios may overlap.
3. Stock Concentration: Mutual fund schemes that hold a few high-conviction stocks in their portfolio are more likely to overlap with other mutual funds that hold the same stocks.
4. Market Cap Bias: Mutual fund schemes that invest in a particular market capitalization say mid-cap or small-cap, are more likely to have an overlap in their portfolio with other mutual funds that have a similar investment strategy.

Does Mutual Fund Portfolio Overlap Affect?

While mutual fund portfolio overlap may seem like a minor issue, it can have a significant impact on your investment portfolio. Here are some reasons why mutual fund portfolio overlap is important:

1. Diversification: Diversification is one of the key principles of investing. By diversifying your portfolio of investments, you can spread your investment risk across different asset classes and securities. Mutual fund portfolio overlap can reduce the diversification of your portfolio, which can increase your investment risk.
2. Concentration: Mutual fund portfolio overlap can also lead to concentration in your investment portfolio. If you invest in multiple mutual funds that have significant overlap, you may end up holding a large amount of the same securities, industries, or investment styles. This can lead to concentration risk, which means that your portfolio will be more exposed to the performance of a particular sector or security.
3. Performance: Mutual fund portfolio overlap can impact the performance of your investment portfolio. If two or more mutual funds in your portfolio hold the same securities or have significant sector overlap, then the performance of your portfolio may be impacted by the performance of those securities or sectors. This can reduce the potential returns of your portfolio.

How to Identify Mutual Fund Portfolio Overlap

The easiest way to identify mutual fund portfolio overlap is to compare the portfolio holdings of two or more mutual funds. You can check the portfolio overlap by comparing the top holdings, sector allocation, and market capitalization of the mutual funds.

There are several tools available online, such as Morningstar and Value Research, that can help you identify mutual fund portfolio overlap.

How Can You Avoid Mutual Fund Portfolio Overlap?

It is important to note that some degree of overlap is normal and expected in mutual fund investing. However, too much overlap can be a problem. Here are some tips you can follow to avoid mutual fund portfolio overlap:

1. Understand your investments: Before investing in a mutual fund, make sure you understand its investment strategy, holdings, and sector allocation. This will help you identify potential overlap with other funds in your portfolio.
2. Diversify across asset classes: Diversify your investment portfolio across different asset categories, such as stocks, bonds, and commodities. This can help reduce the impact of overlap in any one asset class.
3. Diversify across sectors: Diversify your investment portfolio across different sectors or industries. This can help reduce sector overlap between different mutual funds in your portfolio.
4. Use a tool to analyze your portfolio: There are several tools available that can help you analyze your investment portfolio and identify potential overlaps. These tools can help you make informed investment decisions.

Benefits of Diversification in Mutual Fund Portfolio

Diversification is an important aspect of investing that can help to reduce risk and improve returns. When it comes to mutual fund investing, diversification is achieved by holding a mix of different securities in a portfolio. By diversifying their portfolio, investors can enjoy several benefits, including:

1. Reducing risk: One of the main benefits of diversification is that it can help to reduce risk. By holding a variety of securities in a portfolio, investors can minimize the impact of any single security on the overall portfolio. If one security performs poorly, the losses may be offset by gains in other securities.
2. Improving returns: In addition to reducing risk, diversification can also help to improve returns. By holding a mix of securities with different risk profiles, investors can benefit from the higher returns of riskier securities and the stability of less risky securities.
3. Capitalizing on market trends: Diversification also allows investors to capitalize on market trends. For example, if one sector is performing well, a diversified portfolio may include stocks from that sector, which can help to boost returns. On the other hand, if a particular sector is underperforming, a diversified portfolio may have limited exposure to that sector, which can help to limit losses.
4. Providing exposure to different asset classes: Diversification also allows investors to gain exposure to different asset classes, such as bonds, stocks, and real estate. Each asset class has its own risk profile and return potential, and by holding a mix of these assets, investors can benefit from the strengths of each.

Conclusion

Mutual fund portfolio overlap can be a double-edged sword, offering the potential for higher returns but also exposing investors to increased risks. While some degree of overlap is inevitable, excessive overlap can lead to concentrated positions and reduced diversification, undermining the very purpose of investing in mutual funds. To avoid portfolio overlap, investors can use various tools, such as analyzing fund holdings and tracking errors, to make informed investment decisions. By diversifying their investments across multiple funds, investors can reduce the risk of losses and achieve their financial goals in a more stable and sustainable manner. With the right approach and mindset, mutual fund investors can navigate the complex and ever-changing landscape of the financial markets and reap the rewards of long-term investing.