Learn how mutual fund overlap can increase investment risks and discover effective strategies to identify and minimize it for a more balanced portfolio.
A mutual fund portfolio is a collection of different financial assets such as stocks, bonds, etc., managed by a professional fund manager. Investors pool their money into funds, which provides diversification. But when it comes to diversification, one common problem persists, i.e. portfolio overlapping.
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Mutual fund overlap occurs when an investor has multiple mutual funds investing in the same or similar stocks, or assets. This reduces portfolio diversification and increases risk.
To reduce portfolio overlap, it’s important to keep in mind that your new fund investment doesn’t duplicate your existing ones. Regularly reviewing your portfolio allows you to spot and address any overlapping holdings. Additionally, using online tools to analyze your fund holdings can help identify overlaps effectively.
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This article explains ways to understand and identify mutual fund overlap problems so that investors can improve their portfolios.
Effects of mutual fund overlap:
- Diversification is reduced, which leads to concentration and increases risk.
- An investor may have to pay fees to multiple fund managers for the same asset.
- Selling shares in multiple overlapping funds can affect liquidity.
Jiral Mehta, Senior Research Analyst, FundsIndia, says there are tools available online to identify overlap in mutual fund schemes. There is a risk associated with a high overlap, so it is better to limit the overlap to 40%, she adds.
“For equities, we prefer diversifying the equity portfolio based on investment styles mainly Quality, Value, Blend, Mid/Small Cap and Momentum. This offers adequate diversification and ensures that the portfolio at an aggregate level provides consistent performance with significantly lower volatility (thanks to diversification). You can choose funds that are managed based on the above styles and also ensure that the overlap between schemes is low or limited to 40%,” according to Mehta.
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Ways to reduce mutual fund portfolio overlap:
Equity funds:
Diversification: Invest in different market segments and sectors. This will reduce risk.
Different company sizes: Invest in large-cap, mid-cap, and small-cap funds.
Investment styles: Choose different investment styles such as value, growth or dividend strategies.
International funds: Also invest in international or sector-specific funds to enhance your portfolio.
Debt funds:
Diversified debt instruments: Invest in different debt instruments, maturities, and credit quality.
Interest rate consideration: Create a mix of short-term, medium-term, and long-term debt funds.
Credit ratings: Divide investments across government securities, corporate bonds, and other fixed-income instruments.
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These measures can help you reduce overlap in your mutual fund portfolio and achieve better diversification.
