Mutual Fund Portfolio Overlap: Meaning and How to fix it

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Investing in mutual funds is a straightforward way to diversify across companies, sectors, and asset classes. Many investors select multiple funds to spread risk and enhance returns. However, if these funds hold many of the same stocks, true diversification is not achieved. This situation is known as mutual fund portfolio overlap.

This article explains what portfolio overlap is, why it occurs, its impact on returns, and practical steps to address it for effective diversification.

What is Mutual Fund Portfolio Overlap?

Mutual fund portfolio overlap happens when two or more funds in your portfolio hold significant portions of the same stocks or securities. For example, let’s say you invest in two different large-cap funds. Both are run by different asset management companies, but they each have Reliance Industries, HDFC Bank, and Infosys as their top holdings.

Although you may believe you are diversifying, your portfolio remains highly dependent on the performance of these companies. Essentially, portfolio overlap results in limited diversification despite holding multiple funds.

Why Does Portfolio Overlap Happen?

Portfolio overlap is common among investors. The following are key reasons it occurs:

1. Category Restrictions

Mutual funds are regulated by SEBI in India, which defines strict categories. For example, large-cap funds must invest at least 80% of their assets in the top 100 companies by market capitalization. With a limited pool of companies to choose from, most funds in the same category tend to invest in the same stocks.

2. Popular and High-Quality Stocks

Blue-chip companies such as Reliance, TCS, and ICICI Bank are favored by many fund managers for their size, liquidity, and strong fundamentals. As a result, these stocks frequently appear in multiple funds, increasing overlap.

3. Similar Investment Styles

Fund managers often follow similar strategies. For instance, two different growth-oriented funds may both load up on technology stocks, leading to overlap.

4. Market Trends

When certain sectors are doing well—like IT or banking—multiple funds may flock toward the same set of stocks in that sector. This herd behavior also adds to overlap.

5. Same AMC’s Fund Style

Sometimes, even funds from the same asset management company (AMC) overlap. This happens because AMCs often have a certain investment philosophy that carries across different schemes.

Why is Portfolio Overlap a Problem?

At first glance, overlap might not seem like a big deal after all, good companies are good investments, right? But too much of the same thing can backfire. Here’s why:

Reduced Diversification: The whole point of investing in mutual funds is to spread risk. If your funds all invest in the same companies, you aren’t really diversified.
Higher Risk Exposure: If the overlapping stocks underperform, your entire portfolio could take a bigger hit than expected.
Illusion of Diversification: On paper, you may own five or six funds, but if 40% of them are in the same companies, your portfolio is more concentrated than diversified.
Missed Opportunities: When too much money is tied up in the same stocks, you miss out on growth opportunities from other sectors or companies.

How to Identify Portfolio Overlap

The good news is that identifying overlap is not as complicated as it sounds. Here are a few simple methods:

Check Fund Factsheets: Every mutual fund publishes a factsheet with details about its top holdings. If you notice the same stocks appearing across multiple funds, that’s a sign of overlap.
Use Online Tools: Several online platforms and apps allow you to upload your portfolio and check the overlap between funds. They show you the percentage of common holdings, making it easier to decide whether you need to rebalance.
Look at Portfolio Concentration: Check if a large portion of your portfolio is concentrated in one sector or set of companies. For example, if you see too much exposure to banking and IT across different funds, overlap is likely.
Seek Professional Advice: If you find it hard to analyze your portfolio, a financial advisor can do a detailed overlap check for you.

How to Fix Portfolio Overlap

If you discover significant overlap in your mutual fund portfolio, don’t panic it can be fixed with some strategic adjustments. Here’s how:

1. Limit the Number of Similar Funds

Investing in too many funds of the same type (like multiple large-cap funds) is unnecessary. One or two well-chosen funds from each category are usually enough.

2. Choose Funds with Different Mandates

Mix funds across categories like large-cap, mid-cap, small-cap, multi-cap, and sectoral funds. This ensures your money is spread across a wider universe of stocks.

3. Add Index Funds and ETFs

Index funds and exchange-traded funds (ETFs) often provide simple, cost-effective diversification. You can pick funds tracking different indices (like Nifty 50, Nifty Next 50, or Nifty 500) to reduce overlap.

4. Diversify Across Asset Classes

Don’t just stick to equity funds. Adding debt funds, gold funds, or international mutual funds can give your portfolio broader exposure and reduce reliance on a single market.

5. Review Your Portfolio Regularly

Market trends and fund strategies change over time. Review your portfolio at least once a year to spot and correct overlaps before they hurt your returns.

Benefits of Avoiding Portfolio Overlap

When you manage and minimize overlap, your portfolio becomes healthier and more resilient. Here’s what you gain:

True Diversification: Your investments are spread across more companies, sectors, and asset classes.
Balanced Risk: Losses in one area can be offset by gains in another.
Stable Returns: Diversification often leads to smoother performance over the long run.
Efficient Use of Capital: Every fund in your portfolio contributes uniquely to your financial goals.

Conclusion

Mutual fund portfolio overlap is a silent problem that many investors ignore. While it may not seem harmful at first, too much overlap can weaken diversification, increase risk, and give you lower-than-expected results.

The key is not to own too many funds but to own the right mix of funds. By choosing funds with different mandates, regularly reviewing your holdings, and diversifying across asset classes, you can fix overlap and build a stronger, more balanced portfolio.

Remember, the goal of investing is not just to own multiple funds but to create a portfolio that truly works together to grow your wealth safely and effectively.

FAQs on Mutual Fund Portfolio Overlap

1. What is portfolio overlap in mutual funds?

It’s when two or more mutual funds in your portfolio invest in the same stocks, reducing diversification.

2. Is some amount of overlap okay?

Yes, small overlaps are normal and unavoidable. The problem arises when a large part of your portfolio is tied to the same stocks.

3. How can I check if my funds overlap?

You can review fund fact sheets, use online portfolio analysis tools, or consult a financial advisor.

4. How do I reduce portfolio overlap?

Choose funds from different categories, diversify across asset classes, and review your portfolio regularly.

5. Does overlap affect returns?

Yes, if overlapping stocks underperform, multiple funds in your portfolio will be impacted, dragging down overall returns.