Portfolio Overlap

Mutual funds offer investors a convenient way to gain exposure to a diverse range of assets managed by professional fund managers. They provide an easy avenue for diversification. However, when building a portfolio of multiple mutual funds, it's crucial to pay close attention to the concept of portfolio overlap. Understanding this overlap is vital for making informed investment decisions and maximising the benefits of diversification.

High overlap among mutual fund investments is unfortunately quite common among investors, often occurring without their awareness. This phenomenon can be attributed to several factors.

Investors may gravitate towards funds with comparable investment strategies. For instance, multiple large-cap growth funds are likely to hold positions in many of the same companies.

Asset management companies (AMCs) frequently offer several funds with analogous themes. If an investor selects funds from the same AMC, overlap is inevitable.

High overlap undermines the fundamental principle of diversification, which aims to mitigate risk by spreading investments across different assets. When a portfolio is heavily overlapped, diversification becomes ineffective.

If a particular market sector or type of stock experiences a downturn and an investor's funds are highly overlapped, the entire portfolio becomes more susceptible to losses.

Mutual fund portfolio overlap occurs when two or more funds within your portfolio hold some of the same underlying securities. The degree of overlap can vary significantly. Funds with high overlap invest in many of the same stocks, whereas funds with low overlap have minimal shared holdings. This overlap impacts the overall diversification of your investment portfolio.

Mutual fund portfolio overlap is common, especially within the same category. For example, ICICI Prudential Bluechip Fund and SBI Bluechip Fund exhibit a moderate overlap of 47%. This means they share ownership of 31 stocks, creating a balanced mix of diversification and focused investment strategies.

This means they invest in many of the same blue-chip stocks across various sectors, focusing on banking and finance, information technology, pharmaceuticals, and consumer goods. Reliance Industries, HDFC Bank, ICICI Bank, Infosys, and Larsen & Toubro represent the most significant overlapping holdings.

The overlap includes stocks from diverse sectors like pharmaceuticals (Sun Pharma, Cipla), auto (Maruti Suzuki, Hero MotoCorp), and consumer goods (ITC, Hindustan Unilever). The substantial overlap indicates that these funds offer similar core exposure, reducing the diversification benefits of holding both.

Here are the steps to follow:

• Risk Management: Overlapping funds increase your exposure to the same underlying securities. If several of your funds heavily invest in a sector or company that underperforms, the negative impact on your portfolio will be amplified. Excessive overlap can inadvertently create a less diversified and potentially riskier portfolio.
• Diversification: One of the primary benefits of investing in mutual funds is diversification. By selecting funds with low overlap, you better distribute your investments across different stocks, industries, and market segments. This risk-spreading helps mitigate the potential impact of negative market movements on your entire portfolio.
• Investment Strategy: When choosing mutual funds, it's essential to consider your overall investment strategy. If you want broad market exposure, choosing several funds that all invest in the same large-cap companies might not be the most effective approach. By analysing overlap, you can identify funds that complement each other and create a well-rounded portfolio aligned with your goals.
• Cost Efficiency: If two or more of your funds own very similar stocks, you could be paying multiple management fees for exposure to essentially the same assets. Understanding overlap and potentially consolidating holdings can help optimise returns and minimise expenses.

• Dynamic Portfolios: Mutual fund holdings change frequently as fund managers adjust their portfolios in response to market conditions. An overlap analysis represents only a snapshot in time. The overlap may have shifted by the time you use the results to make decisions.
• Category Bias: Significant overlap is expected within the same fund category. For example, large-cap funds will naturally invest in many of the same blue-chip stocks. Therefore, overlap percentages alone don't tell the whole story about diversification.
• Misinterpreting Results: A high overlap percentage doesn't necessarily mean you need to take immediate action. Consider factors like your overall risk tolerance, time horizon, and the investment styles of the overlapping funds before making portfolio adjustments.
• Data Focused: Portfolio overlap analysis is just one tool in an investor's toolbox. It's vital to consider a fund's track record, investment philosophy, sector allocations, fees, and overall suitability for your needs alongside overlap data.

• Analyse the Extent of Overlap: Start by determining the actual percentage of overlap between your funds. A small amount of overlap is typical, but significant overlap (depending on your risk tolerance) needs attention.
• Assess Investment Styles: Determine if the overlapping funds have similar investment mandates (value, growth, large-cap, etc.). Overlap between funds with the same style increases concentration risk, whereas overlap across different styles could offer diversification benefits.
• Evaluate Your Overall Portfolio: Consider how the overlap affects your entire portfolio's diversification. Overlap between two funds is more concerning if they represent a large portion of your holdings, and also, considering your risk tolerance, excessive overlap might be less suitable for conservative investors.
• Take Action: Adjust your portfolio by selling parts of overlapping funds and investing in different assets for better diversification. You can use other tools like Dezerv’s Wealth Monitor app to get suggestions on your portfolio.

Mutual fund portfolio overlap occurs when two or more mutual funds hold some of the same underlying securities. Some overlap is natural, especially between funds in the same category. However, excessive overlap can increase risk and undermine the benefits of diversification. Investors should be aware of portfolio overlap and consider factors like performance and expense ratios before deciding whether to adjust their holdings. This can be done by using Dezerv’s portfolio overlap tool.