‘Mutual fund investments are subject to market risk.’ One way to consider and act on this warning is through portfolio diversification. It involves spreading the investment across different sectors such that the downfall of one investment does not lead to the overall loss of the investment. But,

Is your diverse portfolio actually diversified?

There also exists the condition of false portfolio diversification, where, though it may seem to be diverse, it actually isn’t. Its consequences can be unfavourable, and hence, information on this aspect is essential. So, let’s learn about mutual fund overlap to help you ensure practising actual diversification.

What is Mutual Fund Overlap?

If your mutual fund investment holds the same assets or securities, it is referred to as mutual fund overlap. Here, while your portfolio seemingly is diversified, it’s actually not. The condition is ‘false diversification’, where the investor ends up with holdings of the same bonds or companies.

An example of mutual fund portfolio overlap is the presence of two different large-cap funds. If the major investments are in the same companies, it isn’t a proper diversification. Hence, this is the representation of false diversification and mutual fund overlap.

Why Does Mutual Fund Overlap Occur?

The occurrence of portfolio overlap can occur due to the following reasons:

• Investing in more than one mutual fund falling in the same category, such as large-cap or mid-cap

• Preference for high-performing liquid companies

• Choice of specific themes or sectors to hold the same set of stocks in that segment

• Combining index and active funds tracking the same benchmark

• Lack of thorough assessment before making the investment

Impact of Mutual Fund Overlap

The mutual fund portfolio overlap leads to multiple risks. Here are the insights into the same:

• Poor diversification: Since the investments involve duplicated holdings, the diversification of the portfolio is never achieved

• Amplified loss risk: The fall of one security will be witnessed in other investments as well. Thus, the overall risk and loss increase.

• Increased cost: Overlap in mutual funds leads to paying fees for multiple funds, even though many of the underlying assets are the same

• Lower returns: Since the portfolios aren't diversified, investors may miss out on potential gains from better-performing opportunities

Detecting Mutual Fund Overlap

The presence of fund overlap can be identified in multiple ways. Here is how to do it:

Using the Formula

The mutual fund portfolio overlap between two different funds is possible through the following formula:

Overlap = Number of common stocks (each counted once per fund)/total number of unique stocks across both portfolios

The resultant value will help identify the portfolio risk of redundancy due to overlap. A higher value will indicate poor diversification, while a lower value will represent proper diversification.

Manual Comparison

Check the holdings of each mutual fund in your portfolio. If there are common stocks across different funds, it indicates MF overlap. For instance, if you invest in a healthcare sector fund and a large-cap fund, both might hold shares of the same company. This reduces portfolio diversification.

Perform Category Check

Review the categories of your mutual fund investment. Compare their holdings to identify potential overlap.

Verify Previous Fund Performance

You can also check the historical performance of your funds. If there are similar return patterns from any funds in different market conditions, it can be representative of a shared investment style or overlapping holdings.

Use Online Tools

You can also find multiple online tools that provide insights into portfolio overlap. You simply need to enter the mutual fund scheme names. These tools will show the percentage of overlapping holdings between selected funds.

Complete Portfolio analysis

You can analyse your full portfolio by comparing all fund holdings for shared securities. If there are, it indicates mutual funds overlap.

Getting Expert Help

If you doubt the presence of mutual fund overlap or need to get the same verified, a professional can offer accurate insights. They will also offer specific recommendations depending on your needs and goals.

Tips to Avoid Mutual Fund Overlap

Mutual fund overlaps can be avoided by using the following strategies:

• Ensure proper diversification: Research thoroughly and then invest. Select the large cap, mid cap, small cap, and sectoral funds to reduce the concentration risk. Include a few funds from each category rather than focusing on any one.

• Evaluate the fund holdings: The thorough review will include gaining insights into stock holdings in funds. Check at least the top holdings and select the ones with unique companies across the funds.

• Select funds with different investment strategies: The different or unique investment strategies of funds are equivalent to less overlap. You can combine a growth-oriented fund with a value-based fund or a domestic equity fund with an international fund for better diversification.

• Leverage online tools: The common holdings can be easily detected via mutual fund overlap calculators. : The rupee cost averaging offers protection from market ups and downs.

• Reducing the quantity of funds: The quality values over quantity. Investment in a large number of funds does not necessarily mean better diversification, but may result in duplication. Hence, be informed about the investment.

• Choose funds with different benchmarks: Index funds following the same index are likely to have identical portfolios.

• Rebalance the portfolio: It is suggested to be done at regular time intervals to ensure the diversification remains effective in changing market conditions. A quarterly or half-yearly report is considered appropriate.

Conclusion

Mutual fund overlap is a silent threat to portfolio diversification. With the high possibility of its occurrence, it may remain hidden until thoroughly assessed. The consequences of mutual fund overlap can be high losses due to a high concentration of holdings in a few common stocks. Hence, it is necessary to identify the presence of MF overlap and avoid it. Follow the above-mentioned tips to prevent mutual fund overlap, or seek professional guidance for the right decision-making .

The sector(s)/stock(s)/issuer(s) mentioned in this presentation do not constitute any research report/recommendation of the same and the Fund may or may not have any future position in these sector(s)/stock(s)/issuer(s).

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.