December 14, 2023

Mutual Fund Overlap

Mutual Fund Overlap

Mutual fund overlap happens when an investor has more than one mutual fund that invests in the same stocks or industries. This makes the investor’s portfolio less diverse and could increase their risk.

Content :

What Is Mutual Fund Overlap?

Mutual fund overlap happens when an individual’s investment portfolio contains different mutual funds with similar holdings, resulting in overlapping investments. This redundancy can increase risk and reduce the benefits of diversification.

For instance, if an investor holds two mutual funds, and both funds have a significant percentage of their portfolio in the same company’s stock, there is an overlap. This overlap can lead to increased exposure to specific stocks or sectors, defeating the purpose of diversification. 

Example of Mutual Fund Portfolio Overlap

An example of mutual fund overlap is when an investor has two mutual funds, Fund A and Fund B, and both funds have substantial investments in the same companies, like Infosys and TCS, leading to increased concentration in these stocks.

How To Check Overlapping In Mutual Funds?

To check for overlap in mutual funds, investors can analyze the fund holdings and compare the common stocks between different funds in their portfolios. This process helps identify the degree of overlap and the concentration of investments in particular stocks or sectors.

  • Review Fund Holdings: Regularly examine the portfolio holdings of your mutual funds to identify common stocks.
  • Use Overlap Analysis Tools: Various online tools can compare mutual fund holdings and identify overlaps.
  • Compare Sector Allocation: Assess if the funds have significant investments in the same sectors or industries.
  • Monitor Stock Concentration: Watch for high concentrations of the same stocks across different funds.
  • Evaluate Portfolio Regularly: Continuously evaluating your overall portfolio helps maintain diversification and reduce unintended risks.

How Can You Reduce Mutual Fund Portfolio Overlap?

To reduce mutual fund portfolio overlap, investors should diversify across different asset classes and sectors and choose funds with distinct investment objectives and strategies. This approach minimizes redundant investments and enhances portfolio diversification.

For instance, an investor realizes that two of their equity funds have significant overlap in IT sector stocks. To reduce this overlap, they could:

  • Rebalance Portfolio: Shift some investments from one of these funds to another fund with a different focus, like a healthcare or infrastructure-focused fund.
  • Choose Diverse Fund Types: Invest in funds with distinct strategies, like a combination of growth, value, and index funds, to ensure broader market exposure.
  • Sector Diversification: Select funds that concentrate on different sectors or themes, reducing the concentration risk in any sector.
  • Periodic Review: Regularly review the fund holdings and make adjustments to maintain a well-diversified portfolio.
  • Consult a Financial Advisor: Seek professional advice to optimize the portfolio mix and ensure alignment with investment goals.

Causes of Mutual Fund Overlap

A main reason for mutual fund overlap is choosing several funds carelessly without closely checking what they invest in. This can accidentally result in investing too much in the same stocks or business areas.

  • Lack of Research: Investors often need to analyze the underlying assets to choose funds based on past performance, resulting in overlap.
  • Similar Fund Objectives: Many mutual funds may have overlapping objectives, particularly within the same fund category, leading to similar stock selections.
  • Market Capitalization Bias: Funds, especially those focusing on large-cap stocks, often invest in the same popular companies, causing overlap.
  • Sectoral Trends: Trends or bullish outlooks in certain sectors can lead multiple funds to invest heavily in those sectors, increasing overlap.
  • Advisor Recommendations: Sometimes, financial advisors may recommend similar funds to different clients, inadvertently creating overlap.

Effects of Mutual Fund Overlap

The main effect of mutual fund overlap is reduced portfolio diversification, which can increase risk and diminish the potential for higher returns. Overlap may lead to concentrated exposure to specific stocks or sectors, amplifying the impact of market fluctuations on the portfolio.

  • Increased Volatility: Overlapping investments can heighten portfolio volatility, especially if the overlapping stocks or sectors experience sharp price movements.
  • Performance Limitation: Excessive overlap can limit portfolio performance, as redundant investments may not add additional value but mirror each other’s gains and losses.
  • Risk Concentration: Overlap often results in an unintentional concentration of risk in certain stocks or sectors, making the portfolio more susceptible to specific market risks.
  • Inefficient Asset Allocation: Overlap can lead to inefficient asset allocation, where the portfolio’s assets are not optimally distributed across different investments.
  • Higher Transaction Costs: Regular rebalancing to address overlap might incur additional transaction costs, reducing overall investment returns.
  • Difficulty in Tracking: Managing and tracking a portfolio becomes more challenging with significant overlap, as it complicates the assessment of individual fund performance.

What Is Mutual Fund Overlap?- Quick Summary

  • Mutual fund overlap is when you own several mutual funds that invest in similar stocks or sectors. This means your investments aren’t as varied, which can increase risk instead of spreading it out.
  • A typical example includes two mutual funds in a portfolio having a high percentage of their assets invested in the same companies, increasing risk if those stocks underperform.
  • Overlap in mutual funds can be identified by analyzing fund holdings, using online tools for overlap analysis, comparing sector allocations, and regularly evaluating the portfolio for common stock concentration.
  • Investors should diversify across various asset classes and sectors to minimize overlap, select funds with different objectives and strategies, and regularly review and rebalance their portfolios.
  • Common causes of overlapping include a lack of thorough research, similar objectives of chosen funds, market capitalization bias, trending sectoral investments, and standardized advisor recommendations.
  • Overlap can lead to increased risk from concentrated investments, diminished diversification benefits, and potential underperformance in a market downturn.
  • Want to diversify with mutual funds? Alice Blue helps you do that at no cost.

Mutual Fund Overlap – FAQs

1. What Is Mutual Fund Overlap?

Mutual fund overlap refers to the situation where an investor’s multiple mutual funds hold a significant proportion of their investments in the same stocks or sectors, leading to reduced diversification and potentially increased risk.

2. Can I invest in two mutual funds at the same time?

Yes, you can invest in multiple mutual funds at the same time. However, it’s essential to ensure that the funds have different investment strategies or focus on other sectors to avoid significant overlap.

3. Can I have multiple SIP mutual funds?

Yes, investors can have multiple Systematic Investment Plans (SIPs) in various mutual funds. This can be a part of a diversified investment strategy, but one should be mindful of potential overlap in the funds’ underlying assets.

4. How much MF overlap is acceptable?

There’s no fixed acceptable level of mutual fund overlap; it depends on individual investment goals and risk tolerance. However, less overlap is generally preferable to maintain diversification and manage risk effectively.

5. Is portfolio overlap good or bad?

Portfolio overlap is usually seen as unfavorable because it can lead to excessive concentration in certain stocks or sectors, increasing risk and potentially reducing the benefits of diversification.

6. How do you calculate overlap funds?

Overlap in funds can be calculated by analyzing the individual holdings of the mutual funds in your portfolio and identifying common stocks or sectors. Several online tools and platforms can assist in calculating this overlap.

7. How do you prevent overlapping in mutual funds?

To prevent overlap, diversify investments across different asset classes and sectors, select mutual funds with distinct investment strategies, regularly review portfolio holdings, and consider consulting a financial advisor for personalized portfolio management.

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