What Is Portfolio Overlap In Mutual Fund And How Can You Avoid It?

Portfolio overlap in a mutual fund is holding the same stocks in two different schemes floated by fund houses
mutual funds
mutual funds

Mutual funds are known for diversification, the mantra of successful investing. However, diversification may not yield positive results always, mainly when the same stocks are held in multiple schemes.

This overlapping of stocks in schemes is commonly called a portfolio overlap. But it could be hard for the fund managers to avoid an overlap all the time, given a smaller investing universe. Hence, investing in schemes having the same or similar constituents in the portfolio may not be productive.

Sandeep Bagla, CEO of TRUST mutual fund, said that an overlap happens when one invests in funds that put the money in the same set of securities. Bagla added that a “high overlap means the investor is not able to diversify effectively, even though he has invested in different schemes.”

In an example, Bagla explains, “If an investor invests in three large-cap schemes, whose top 10 holdings are similar, the overlap is high. To minimise the overlap, one could diversify the holdings across different categories of funds.”

If you are investing in a large-cap fund, most such funds will have more or less similar constituents, but the per cent of allocation in the companies may be different. It is due to the mandate to invest in the top 100 companies based on market capitalisation.

For instance, in the case of large-cap schemes, DSP Top 100 and HDFC Top 100, the former has 38 stocks in the portfolio, while the latter has 59 shares. If these two schemes have 19 common stocks, the number of uncommon shares in HDFC will be 40 and 19 in DSP. So, the portfolio overlap is 48 per cent.

How To Avoid Mutual Fund Overlap?

Mutual funds are categorised into large-cap, mid-cap, small-cap, multi-cap, value funds, and contra funds, among others, by the Securities Exchange Board of India (Sebi).

Nirav Karkera, Head, Research, Fisdom, a stock and mutual fund investing app, said, "An important aspect that most miss on checking is if an incremental fund effectively diversifies investments at an underlying security level. Often, two or more funds may be invested in similar securities. The similarity between two or more funds is often referred to as an overlap. Such an overlap among funds in a single portfolio, beyond a certain threshold, may be counter-productive to performance while the benefits of diversification become virtually non-existent."

Hence, invest in different asset classes like large-cap, mid-cap, small-cap, others., after comparing the portfolio of various fund houses to avoid overlap.

Kartik Parekh, a Sebi-registered investment advisor and co-founder of the fintech platform Gochanakya, says that investors should be careful of overlap because it can undermine the principle of portfolio diversification. But the purpose of diversification will fail if we fail to diversify the right way.

“Diversification is done to minimise the risk of an investment. Diversification across the same type of funds would not serve the purpose,” asserts Parekh.

“People can avoid investing in funds which are managed by the same fund manager. It is because fund managers tracking a particular sector/capitalisation may have a strategy or view towards it which may incline his managed fund’s portfolio towards certain stocks,” Parekh explains.

But to avoid overlapping and diversification, do not invest in many funds. Parekh adds that when people invest in many funds in the same class, they run the risk of overlapping; hence, they should put their money across different fund categories, like gold, energy, etc., according to their investment goals and risk appetite.

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