Mutual Fund Portfolio Crossover: What Is It & How to Reduce It

Mutual funds are a great way to build wealth. However, understanding mutual fund portfolio overlap is key to making informed, diversified investments.

What is Mutual Fund Portfolio Overlap?

Mutual fund portfolio overlap is when multiple mutual funds in your portfolio own the same stocks or securities. In investment speak, it’s like using the same puzzle piece in different places.

What is Portfolio Overlap in Mutual Funds?

Mutual fund portfolio overlap is not just about counting the number of common stocks between funds but also the weighting or allocation of those stocks. A higher allocation to common stocks means more overlap between funds.

Factors to Consider in Mutual Fund Overlap

Mutual fund overlap in mutual funds involves more than just counting common stocks. Here are some other factors to consider:

  • Different Weights: Differences in the weighting or allocation of unique and common stocks between mutual funds can impact overall performance.
  • Risk Metrics: Standard deviation and Sharpe ratio are valuable metrics to measure volatility and risk of fund returns.
  • Consistency and Performance: It’s essential to check a fund’s performance against benchmarks and compare it with other funds in the same category.
  • Reputation of AMCs and Fund Managers: Check the track record of fund managers and the reputation of the Asset Management Company (AMC) in the market.

Why Does Portfolio Overlap Happen?

SEBI’s Category-Wise Mandate: SEBI, the market regulator in India, has guidelines for mutual fund investments based on categories. Large-cap funds, for example, have to invest a large portion of their assets in the top-performing stocks in the market, and hence the familiar stock universe is limited. Due to these restrictions, there is often overlap between funds in the same category.

AMC Specific Investing Style: Asset Management Companies have different investment styles, approaches and philosophies. Funds from the same AMC may overlap because of similar stock selection strategies.

Impact of Mutual Fund Overlap

Mutual fund overlap has:

  • Reduced Diversification: Overlap reduces diversification and makes the portfolio more vulnerable to concentrated risks.
  • Duplicate Holdings: Overlapping investments can lead to duplicate holdings and impact overall portfolio performance.
  • Increased Costs: Having similar stocks in multiple funds can increase transaction and management costs.
  • Liquidity Risks: Selling shares simultaneously in multiple overlapping funds can impact liquidity due to market price impact.

How to Reduce Overlap in Your Mutual Fund Portfolio

  • Diversification: Reduce overlap by diversifying across different fund categories. This increases the stock universe and reduces overlap between categories.
  • Invest with Multiple AMCs: Choose funds from multiple AMCs to avoid overlap due to similar investing styles. Diversifying across different fund houses reduces overlap.

Challenges and Solutions in Managing Portfolio Overlap

Overlap increases portfolio risks during market downturns. Diversifying by strategy and asset mix is challenging when managing multiple funds.

Can you avoid Overlap?

You may not be able to achieve zero overlap. But diversification of assets and sectors, along with thorough research can help minimise overlap.

Should you worry about Mutual Fund Overlap?

Investors must know about portfolio overlap. Periodic portfolio checks are a must. Focus on managing outcomes, checking fund consistency and checking manager skills.

Why Diversify Your Mutual Fund Portfolio?

Diversifying across asset classes and sectors gives you maximum returns with minimum risks. This strategy provides downside protection and controls market volatility by reducing the impact on the portfolio when one asset underperforms.

Conclusion

Investors who want to create a diversified strategy must know about mutual fund portfolio overlap. Portfolio overlap happens when mutual funds hold similar or the same stocks, resulting in an unintentional concentration of securities. Mutual funds are designed to diversify risks by investing across different assets. However, portfolio overlap can reduce this benefit by exposing the investor to higher risks in specific assets or sectors. If you have multiple funds that invest heavily in top-performing stocks, your portfolio can become too concentrated, and you may be more exposed to market risks.

Using overlap detection tools can also help. These tools will analyse the overlap between mutual funds and give you insights on how to diversify your portfolio. By knowing and minimising mutual fund overlap, you can create a robust investment strategy that gives you stable long-term returns with minimal risks. This will provide you with a balanced portfolio that is strategically diversified and aligned to your goals.