Mutual Fund Overlap: Why It Matters for Your Portfolio

Before 2018, different Asset Management Companies (AMCs) had their own definition of what constituted a large-cap, mid-cap, or small-cap fund. A fund may have called itself a large-cap fund but allocated significant assets in small-cap stocks. In 2018, the Securities and Exchange Board of India (SEBI) issued guidelines for classifying mutual funds into large-cap, mid-cap, and small-cap categories to make things more transparent and consistent, so the classification of mutual fund schemes across different asset management companies would be uniform.

For example, now large-cap mutual funds have to invest at least 80% of their corpus only in the top 100 companies by market capitalization. This change by SEBI was important, however, it also amplified a concern for investors – Mutual Fund Overlap. The guidelines increased the chances of portfolio overlap, particularly among large-cap and mid-cap funds. Since all large-cap mutual funds are required to invest in the same pool of the top 100 companies, many mutual funds end up holding the same stocks.

That’s right. Even if you are holding multiple mutual funds, your fund portfolio may be lacking in diversification. There are many other reasons why an overlap happens, so it becomes essential to track and reduce it. Here’s all you need to know about Mutual Fund Overlap and how you can keep it under control.

What is Mutual Fund Overlap?

A mutual fund pools money from a large number of investors and invests the corpus in a basket of securities such as stocks, bonds, ETFs, REITs, or other assets, depending on the fund’s investment strategy. This is why mutual funds are known for their diversification. Investing in various funds further expands this advantage and reduces risk.

But there are instances when you invest in multiple mutual funds, you might end up owning funds that have identical holdings. For example, imagine you hold two mutual funds – Fund A and Fund B. In Fund A the manager has allocated 10% of the fund’s holdings to Stock X and Y, and in Fund B, Stock X and Y take up 8% of the portfolio. You might think you’re investing in two completely different funds, but in reality, you may be holding a similar set of stocks in both funds, which results in what is called a Mutual Fund Overlap. This way, your portfolio becomes more concentrated than you intended.

Having a percentage of MF overlap is of course common as fund managers will want to invest in good companies or stocks with high potential. However, a significant overlap poses some serious risks, the most important being the dilution of diversification. The goal of diversification is to spread risk across various securities, sectors, and asset classes to minimise the impact of poor performance in any single area.

Even if a particular stock or sector fails, the likelihood of your portfolio taking a nosedive will reduce significantly if you diversify. A Mutual Fund Overlap compromises diversification. You may think you are spreading risk by investing in multiple SIPs, but the hidden overlap will defeat the purpose of diversification.

Understand mutual fund portfolio overlap with an example

Here’s a very simple example that will help you understand how portfolio overlap mutual funds works. Suppose an individual invests in two funds. Fund A is a large-cap fund, and Fund B is a blue chip fund. At first glance, a new investor may think that they are diversifying their investments because the funds have different names and possibly different investment strategies. When the investor looks at the holdings of each fund, they find that there are some stocks that both funds have in common, even though their weightage is not the same. 

For example, Fund A has 8% in Reliance Industries and Fund B has invested 10% in the same stock. On top of that both funds also hold significant positions in HDFC Bank. Fund A has allocated 7%, and Fund B has allocated 6% to it. Even though they are two different funds, there is some stock overlap between them.

An overlap of mutual funds means that there are specific sectors, industries, or stocks that you are overexposed to. If they don’t perform well, your returns can be greatly impacted, even if you think you have diversified your mutual fund portfolio by investing in multiple funds.

Types of Portfolio Overlap

Diversification is not just limited to stocks but also extends to sectors, industries, and countries. It isn’t necessary that market conditions force all these entities in the same direction. For example, the consumer goods industry can be performing well and, on the other hand, the automobile industry might be facing challenges at the same time. Similarly, some countries might be doing well, and some economies might be underperforming due to political reasons.

Overlap can also extend beyond just stocks. The most common kind of portfolio overlap mutual fund is when multiple funds invest in the same underlying securities, especially stocks. But there can be other types of MF Overlap that may or not be as easily detected. One such overlap is sector overlap, where funds invest heavily in the same industry or sector. For example, a large-cap Fund A can invest heavily in banking due to the high market capitalisation of banks.

If you also invest in another mutual fund, Fund B, that focuses on blue-chip stocks, it can also have significant holdings in the banking sector. This means that if the banking sector performs poorly both funds will suffer, leading to higher risk in your portfolio. Similarly, there can be an overlap based on the style of investing. Two different funds, such as a mid-cap growth fund and a small-cap growth fund might invest in 3 or 4 same stocks because those companies are showing high growth potential.

Identifying Portfolio Overlap in Mutual Funds

Here are a few steps you can take to identify the overlap in your mutual fund portfolio:

1. Check the mutual fund factsheet. A factsheet is a document regularly released by AMCs that provides important information about a specific mutual fund scheme. In it, you’ll find a section dedicated to the composition of the portfolio, which details the fund’s current holdings, like the stocks or bonds in the portfolio, their weightages, and the sectors in which the fund is invested. Having a look at all the factsheets of the funds you’re invested in can help you assess whether there is any overlap with other funds in your portfolio. You can download the relevant fact sheets from AMC websites.
2. Alternatively, you can use an online Mutual Fund Overlap tool. This is the easiest way to check for overlap as all you need to do is enter the relevant funds and the tool will give you an overlap percentage.
3. Sometimes when you review fund returns over different market cycles, you can check for overlap. For example, if the returns from two funds move in sync, it could mean they have similar investment styles or hold many of the same stocks.
4. You can always get professional help from an investment advisor to understand the MF Overlap in your portfolio.

Tools to Measure Mutual Fund Overlap

An online Mutual Fund Overlap tool makes identifying and calculating the level of overlap much easier. All you need to do is select the fund category and the relevant schemes and hit calculate. The tool will show you exactly how much mutual fund portfolio overlap you’ve got based on the latest data, along with the overlapping securities and percentage of corpus allocated to them.

Different tools offer different features. Some allow you to enter four mutual funds, while some only offer two. Morningstar PM and Value Research are two options you can look into to calculate the overlap in your portfolio. Do note that you may need a subscription to view the results of the overlapping securities and weightages.

Strategies to Minimize Mutual Fund Overlap

Once you know your Mutual Fund Overlap, you can take steps to reduce it. You likely won’t be able to completely eliminate it because many large-cap funds invest in reliable performers to varying degrees. Similarly, you’ll find small-cap fund managers investing in the same high-potential stocks that they believe can give high returns. A question arises here. Just how much overlap is fine? There isn’t a strict rule for this, so it would be best to consult a financial advisor about it. Here are the steps you can take to reduce overlap:

1. Diversify your mutual fund investment across different categories. Some categories are similar, such as large-cap, blue chip, and large and mid-cap funds. There’s a good chance you’ll see significant overlap in the stocks held by these funds. To minimise this overlap, you can consider going for funds from different categories, like small-cap and mid-cap growth funds.
2. Often asset management companies have their own investment philosophy which can lead to overlap. Different schemes within a fund house can also share the same fund manager. Consider investing across a wider variety of fund houses.
3. Check before you invest. The information on a portfolio’s holdings is readily available on apps or in fact sheets, so this process is quite easy. The portfolio composition also changes regularly as equity funds are actively managed, so it’s best to keep an eye on the changes and rebalance accordingly.
4. Talk to an investment advisor who can assess your financial situation and create a well-diversified and balanced portfolio that will make sure you are not overexposed to a handful of securities.

Portfolio Overlap vs. Diversification

Portfolio overlap is basically a side-effect of diversification. It can only happen when you invest in at least two different schemes. Here are a couple of key differences between the two:

Factor	Portfolio Overlap	Mutual Fund Diversification
What It Means	Overlap happens when two or more funds in your mutual fund portfolio invest in the same securities, generally stocks.	Diversification is the process of spreading mutual fund investments across different categories of funds.
Risk	Significant overlap can increase risk, because essentially even if you are invested in multiple funds, their underlying stocks are the same and the benefit of diversification has reduced.	The goal of diversification is to reduce risk so that if one asset underperforms, the other assets in your portfolio can help cushion the impact.

Conclusion

There are plenty of tools online that can help you calculate your portfolio overlap. A lower portfolio overlap is better for diversification, but it should not be the only consideration when selecting a fund. In your quest to reduce Mutual Fund Overlap, it’s important to remember that a small amount of overlap is perfectly acceptable. You won’t be able to eliminate it completely, and trying to do so can lead you to choose funds that don’t align with your financial goals, risk tolerance, and investment horizon. 

Your goals should always take priority, so make sure that the objectives of the fund you choose match your own. It’s also important to review your portfolio regularly. The holdings of a fund change constantly, so it is important to make adjustments to ensure that the portfolio overlap stays at an acceptable level.