Understanding Portfolio Overlap in Mutual fund schemes and How to Reduce It

Mutual fund schemes have become a popular investment vehicle for many Indian investors, especially those in Tier II and Tier III cities (Tier II and Tier III cities in India are the smaller urban centre’s experiencing growth and development , having population of Tier II cities range between 50000 to 99999 and Tier III cities range between 20000 to 49999 ). They offer a convenient way to diversify investments and potentially achieve relatively better returns. However, one aspect that investors need to be aware of is portfolio overlap. Understanding and managing portfolio overlap is crucial for maintaining a well-diversified investment portfolio.

Portfolio overlap occurs when multiple mutual fund schemes in an investor's portfolio hold the same securities. This can lead to overexposure to certain stocks or sectors, which may increase the risk of the investment portfolio. For instance, if two or more mutual fund schemes in your portfolio hold significant amounts of the same stock, the performance of that stock will disproportionatelyaffect your overall portfolio.

What Is Portfolio Overlap?

In the context of mutual fund schemes, portfolio overlap refers to the situation where different mutual fund schemes hold many of the same securities. This overlap can occur across various asset classes, including equities, bonds, and other securities. For example, if you invest in two different equity mutual fund schemes, and both schemes have a significant portion of their assets invested in the same set of stocks, you have a portfolio overlap.

Portfolio overlap can be unintentional, especially if investors are not aware of the specific holdings of each mutual fund schemes. This overlap can lead to a lack of diversification, which is one of the primary benefits of investing in mutual fund schemes.

Why Is Portfolio Overlap a Concern?

Diversification is a key principle in investing, aimed at spreading risk across various assets to reduce the impact of any single investment's poor performance on the overall portfolio. Portfolio overlap can undermine diversification by concentrating risk in specific securities or sectors.

When multiple mutual fund schemes in your portfolio hold the same securities, the benefits of diversification are reduced. This can affect the risk-return profile of your investment portfolio. For example, if a particular stock performs poorly and you have significant exposure to it through multiple mutual fund schemes, your portfolio's overall performance will be negatively impacted.

Moreover, portfolio overlap can lead to overexposure to certain sectors. If the overlapping securities belong to the same sector, your portfolio becomes more vulnerable to sector-specific risks. This can be particularly concerning in volatile markets or during economic downturns.

How to Check for Portfolio Overlap

To manage portfolio overlap effectively, it is essential to identify and monitor it. Here are some methods to check for portfolio overlap:

1. Mutual Fund Scheme Fact Sheets: Mutual fund Scheme fact sheets provide detailed information about the schemes holdings. By reviewing the fact sheets of the mutual fund scheme in your portfolio, you can identify common securities and assess the extent of overlap.
2. Online Tools: Several online tools and platforms offer portfolio overlap check services. These tools allow you to input the mutual fund schemes in your portfolio and generate a report highlighting the overlapping securities.
3. Fund Manager Reports: Fund managers periodically release reports that provide insights into the schemes holdings and performance. Reviewing these reports can help you identify any significant overlap in your portfolio.

Strategies to Reduce Portfolio Overlap

Once you have identified portfolio overlap, the next step is to take measures to reduce it. Here are some strategies to consider:

1. Diversify Across Asset Classes: Invest in mutual fund schemes that focus on different asset classes, such as equities, bonds, and real estate. This helps spread risk across various types of investments.
2. Select schemes with Different Investment Strategies: Choose mutual fund schemes with distinct investment strategies and objectives. For example, you can invest in a large-cap schemes, a mid-cap schemes, and a sectoral schemes to achieve diversification.
3. Diversify Across Sectors and Geographies: Ensure that your mutual fund schemes invest in a variety of sectors and geographical regions. This reduces the impact of sector-specific or region-specific risks on your portfolio.
4. Periodic Portfolio Reviews: Regularly review your portfolio to identify and address any overlap. This can be done quarterly or annually, depending on your investment strategy.
5. Consult a Financial Advisor: A financial advisor can provide valuable insights and help you manage portfolio overlap effectively. They can recommend suitable mutual fund schemes and investment strategies based on your financial goals and risk tolerance.

Conclusion

Portfolio overlap is an important consideration for mutual fund schemes investors. By understanding and managing portfolio overlap, you can ensure that your investments are well-diversified and aligned with your financial goals. Regularly checking for overlap and implementing strategies to reduce it can help you maintain a balanced and resilient investment portfolio.

Investing in mutual fund schemes offers numerous benefits, but it is essential to stay informed and proactive in managing your investments. By taking the necessary steps to monitor and reduce portfolio overlap, you can enhance the performance and stability of your investment portfolio.

Additional links:

What is a Mutual Fund? - Beginner's Guide to Investing

AMFI - Introduction to Mutual Funds

Let’s Learn How to Invest in Securities Market