Building a well-diversified mutual fund portfolio is essential for reducing risk and maximizing returns. However, many investors unknowingly fall into the trap of over-diversification by purchasing multiple funds with overlapping securities. This overlap undermines the benefits of diversification, increases risk, and can lead to redundant costs.
In this blog, we’ll explore what mutual fund overlap is, why it matters, and how to identify and minimize it. We’ll also share advanced insights, practical examples, and tools to help you optimize your portfolio for better performance.
What Is Mutual Fund Overlap?
Overlap occurs when two or more mutual funds in your portfolio invest in the same stocks. For example, if Fund A and Fund B both allocate 5% of their holdings to Tata Consultancy Services, that’s considered a 5% overlap.
This is a common occurrence because fund managers often gravitate toward the same high-performing stocks. In fact, the top 100 stocks account for about 60% of the total equity assets under management (AUM) in the mutual fund industry.
Why Does Overlap Matter?
1. Reduced Diversification
Diversification spreads your investments across different stocks and sectors to mitigate risks. However, if your funds hold the same securities, you’re not truly diversifying.
2. Concentration Risk
High overlap increases exposure to specific stocks or sectors. If these overlapping stocks underperform, the impact on your portfolio could be significant.
3. Redundant Costs
Mutual funds charge management fees, and holding multiple funds with similar portfolios means paying for the same investments multiple times, which erodes your returns.
Insights into Overlap Trends Across Fund Categories
- Large-Cap Funds: The average overlap between schemes in this category is about 47%, with some exceeding 60%.
- ELSS Funds: These tax-saving schemes often share an overlap of 30%-80% due to their focus on large-cap stocks.
- Flexi-Cap Funds: Though flexible in allocation, these funds still have an average overlap of 25%, with some cases surpassing 50%.
- Thematic and Sectoral Funds: Funds in similar themes, such as ESG or technology, often hold identical stocks like TCS or Infosys.
Practical Examples of Overlap and Its Impact
- Example 1: An investor holds XYZ Large Cap Fund and ABC Flexi Cap Fund. Both funds invest heavily in Reliance Industries, HDFC Bank, and Infosys. If these stocks underperform, the investor’s entire portfolio could suffer significant losses.
- Example 2: Two mid-cap funds, such as Aditya Birla Sun Life Mid Cap Fund and HDFC Mid Cap Opportunities Fund, might have high overlap, reducing the diversification expected from mid-cap exposure.
Steps to Reduce Overlap
- Opt for Distinct Fund Categories
Avoid choosing funds within the same category (e.g., large-cap funds) unless their investment strategies differ significantly.
- Diversify Across Asset Classes
Incorporate debt funds, international equity funds, or hybrid funds to reduce reliance on overlapping Indian equities.
- Choose Funds with Unique Strategies
Consider factor-based funds (value, quality, momentum) or thematic funds focused on emerging sectors like green energy or artificial intelligence.
- Analyze Portfolio Turnover
Low turnover funds tend to hold the same stocks for extended periods. High-turnover funds may offer better diversification but could increase costs.
Advanced Insights into Overlap
- Impact of SEBI Regulations
While SEBI-mandated fund categorization has reduced overlap, funds within the same category still share many holdings. Investors need to dig deeper into fund fact sheets for clarity.
- Behavioral Bias in Overlap
Many investors mistakenly equate more funds with better diversification. However, this "more is better" mindset often leads to portfolios filled with redundant holdings.
- Tax Implications
Selling overlapping funds to rebalance your portfolio might trigger capital gains taxes. Be mindful of the post-tax impact when optimizing your portfolio.
Tools and Techniques for Portfolio Optimization
- Use Online Overlap Calculators
Several platforms offer easy ways to analyze overlap. Regularly review your portfolio to ensure effective diversification.
- Global Funds for Unique Exposure
Add international equity funds to your portfolio for geographical diversification and lower overlap with Indian equities.
- Gamify Portfolio Analysis
Turn overlap reduction into a fun challenge. Set a goal to reduce overlap by a specific percentage while maintaining returns, and track your progress.
Conclusion: Don’t Let Overlap Undermine Your Returns
Portfolio overlap can silently erode the benefits of diversification, increase risks, and lead to unnecessary costs. By using tools like the Mutual Fund Portfolio Overlap Tool, understanding fund categories, and adopting smart diversification strategies, you can build a robust and balanced mutual fund portfolio.
Take charge of your investments today—analyze, optimize, and ensure every fund in your portfolio contributes to your financial goals.
Discalimer!
The content provided in this blog article is for educational purposes only. The information presented here is based on the author's research, knowledge, and opinions at the time of writing. Readers are advised to use their discretion and judgment when applying the information from this article. The author and publisher do not assume any responsibility or liability for any consequences resulting from the use of the information provided herein. Additionally, images, content, and trademarks used in this article belong to their respective owners. No copyright infringement is intended on our part. If you believe that any material infringes upon your copyright, please contact us promptly for resolution.