As investors, we frequently seek portfolio diversification to reduce risks and maximise rewards. However, a problem rises when multiple mutual fund schemes end up owning comparable stocks, resulting in portfolio overlap.

Portfolio overlap occurs when you are investing in various mutual fund schemes, yet finding a significant similarity in their underlying portfolio constituents. This concentration of holdings across funds may inadvertently amplify risks and compromise the benefits of diversification. 

For example, suppose you have one small-cap fund. But it is not doing well so you buy another small-cap fund that is trending currently for delivering higher returns.

If you check both funds, you will notice that your first and second funds contain nearly identical stocks, indicating overlap. Therefore, proper diversification is necessary even if the fund managers differ.

Reasons for portfolio overlap

While there might be different reasons for portfolio overlap to occur, the following are a few major ones:

• Benchmark Tracking: Many mutual funds seek to replicate a certain market index or benchmark. As a result, they may invest in the same stocks as those present in the benchmark.

• Sectoral Focus: Funds that concentrate on specific sectors or industries are likely to have overlapping holdings. For example, technology funds may invest in similar tech companies.

• AMC or Fund Manager’s investment style or choices: Investment decisions made by fund managers can lead to overlap if they favour similar stocks or sectors.

How to mitigate portfolio overlap

1. Diversify Across Fund Categories: You can systematically diversify across different fund categories. But choose strategically to avoid excessive overlap. Investing in funds from categories with distinct investment universes can help reduce the overlap.

2. Select Funds from Different AMCs: Opt for funds managed by different asset management companies (AMCs) to diversify investment philosophies and stock selection approaches, thereby reducing overlap.

3. Regularly Review Portfolio Overlap: Periodically assess portfolio overlap before investing and monitor it over time. Be vigilant about changes in overlap levels to maintain portfolio diversification.

How to check portfolio overlapping

Several online tools are available to check portfolio overlaps. Simply search on the web for “Mutual fund overlapping tool.” Select the schemes to view the overlapping, percentage of overlap, common and uncommon stocks.

How to reduce portfolio overlap

After identifying overlapping stocks, it’s important to consider ways to eliminate overlap in your portfolio’s sectors.

1. Mix Up Your Investments: Instead of putting all your money into one type of fund, spread it across different categories like direct growth, value and sector-specific funds. This way, even if one category isn’t doing well, others might balance it out.

2. Shop Around: Don’t just stick to one company for all your investments. Invest in funds from different asset management companies (AMCs). Each company might have its unique strategies and approaches, reducing the chance of overlap.

3. Double-Check Your Choices: Before you invest, take a look at what companies each fund holds. Make sure you’re not doubling up on the same stocks across different funds. And keep checking periodically to make sure your portfolio stays diverse.

Remember, while a little overlap is unavoidable, keeping it below 33% is like keeping your portfolio perfectly balanced and flavorful. So, mix, shop and double-check your way to a well-diversified investment portfolio!

Conclusion

Understanding and managing portfolio overlap in mutual funds is crucial for investors. This means knowing when multiple funds you own have similar investments. By recognizing this, you can take steps to reduce risks and balance your portfolio better.

Minimizing overlap is important because it helps to keep your investments stable, makes the best use of your money and makes your investment decisions clearer. Dealing with overlap is vital for making smart financial choices and navigating the changing world of mutual fund investments effectively.

Disclaimer: The above content is for informational purposes only. The 1% News recommends consulting a SEBI-registered investment advisor before investing in any mutual fund.