How to Find & Avoid Multiple Mutual Funds Portfolio Overlapping?
Mutual fund overlap might sound complex at first, but it’s a crucial idea to grasp for anyone looking to invest wisely. Imagine you have multiple mutual funds in your investment portfolio. Now, what if these funds ended up holding a significant number of the same stocks? That’s what we call “mutual fund overlap.” So, what is the meaning of mutual fund portfolio overlap, and how can one avoid it? Let’s read further.
What is Mutual Fund Overlap?
Alright, let’s break this down in simple terms. Imagine you’re putting together a puzzle, but you accidentally use the same piece in two different spots. That’s kind of what happens with mutual fund overlap.
When you invest in portfolio overlap mutual funds, you’re basically giving your money to professional managers who buy stocks and other stuff on your behalf. Now, sometimes these fund managers end up picking the same stocks in different funds they manage. So, your money ends up in those same stocks more than once – like using that same puzzle piece in different parts of your puzzle.
As a result, the overlapping of mutual fund holdings can weaken the advantages of diversification. Diversification aims to lower risk and boost returns by distributing investments among different asset classes, sectors, or securities.
What is Portfolio Overlap in Mutual Funds Meaning?
A mutual fund portfolio is like a basket filled with different types of money-making ingredients – stocks, bonds, and other things that can grow your money. On the other hand, MF portfolio overlap refers to how much the investments in different portfolios resemble each other. It measures how similar the assets are between two or more portfolios. For instance, with equity funds that mainly invest in stocks, there’s a possibility that many of them have invested in the same companies.
We need to understand what we mean by a MF portfolio overlap. So basically, it is just not a number of stocks which are common between two funds. Instead, it involves the shared weight of these stocks.For example, two funds can have fewer stocks in common, but the allocation to those stocks is higher, then the overlap is also high. So, there are tools which are available.
Kartik Shah, Founder of MMY Investments
As an investor, you might initially think it’s a good idea to spread your investments across various equity funds, aiming for diversification. However, the reality could be different. Your money might actually be invested in the same underlying set of stocks. This is known as portfolio overlap, and it actually lessens the level of diversification, reducing the safety of your portfolio.But why does this matter? Well, think about it this way: if you put all your eggs in one basket, and that basket has a hole, you might end up with a lot of broken eggs. Similarly, if your mutual funds have a lot of overlap, you might be putting your money at risk. Therefore, it is important to learn the art of portfolio management & investing.
Top 10 Holdings of the Best Large Cap Funds
Let’s understand by an example of how mutual fund overlap may actually look like before we initiate our mutual fund overlap analyss to compare mutual funds overlap.
Disclaimer: Please note that the above list is for educational purposes only, and is not recommendatory. Please do your own research or consult your financial advisor before investing.
Factors to Consider Along with Mutual Fund Portfolio Overlap
When it comes to mutual fund portfolio overlap, there are a few other important factors to keep in mind to ensure a well-rounded investment strategy. Here’s what you should consider:
- Returns depend on the entire portfolio of a fund and the weights of its stocks. So, even if there’s a significant overlap between mutual funds, the differences in the weights of common and unique stocks can impact performance. This might not be the case for very high overlaps like 80% or more.
- Consider and evaluate metrics that will throw more light on aspects such as how much risk a fund has taken and how volatile its returns are. The fund’s standard deviation indicates the ups and downs in returns. The Sharpe ratio reveals the amount of risk the fund has embraced to achieve its returns.
- Remember that mutual fund overlap check is influenced by monthly portfolio changes. So, another significant measure is a fund’s consistency—how well it has outperformed its benchmark and its category. Both of these metrics are also available within the tool.
- Don’t overlook the track records of the fund manager and the Asset Management Company (AMC). These are important aspects to consider when evaluating a fund.
What are the Causes of Mutual Fund Overlap?
Let’s have a look at the causes of overlap percentage in mutual funds.
- Market Trends: You know how trends can affect what people buy, right? Well, the same goes for investing. Sometimes the types of investments or a specific sector become popular in the stock market. As a result, many portfolios include these popular investments. And guess what? This causes MF portfolio overlap. Example if everyone’s excited about green & renewable energy stocks, multiple portfolios may include the same.
- Similarity in Investment Strategy: This similarity in investment strategy happens for a few reasons. Sometimes, fund managers are inspired by the same trends or information, causing them to make similar investment choices. Other times, they might be following popular strategies that others are using as well.
- Building a Portfolio Aligned with Market Index: When constructing their investment portfolios, individuals frequently refer to market indexes like the Sensex or Nifty 50. Numerous index funds and ETFs are designed to mirror these indices. However, investing in multiple index funds and ETFs that all track the same index can result in MF overlap for investors.
Effects of Mutual Fund Overlap
Here are some of the effects of mutual fund overlap.
- Reduced Diversification: Overlap limits the diversity of investments, making the portfolio more vulnerable to concentrated risks.
- Diminished Returns: Overlapping investments might lead to redundant holdings, impacting overall portfolio performance.
- Higher Costs: Owning similar stocks through multiple funds might increase transaction and management costs.
- Liquidity: Selling shares in multiple overlapping funds simultaneously can affect liquidity due to potential market price impact.
How Can I Reduce Mutual Fund Overlap in My Portfolio?
Here are the best two ways after which you’ll be able to reduce mutual fund overlap in portfolios.
- Diversification is the Key: To decrease portfolio overlap, diversifying your investments across various fund categories is an effective approach. When you allocate funds to different categories, the likelihood of overlap decreases because the range of stocks in your portfolio expands due to the varying universes of stocks in each category.
- Invest through multiple AMCs: To prevent portfolio overlap because of how a fund company invests, you can just choose funds from different companies. Don’t pick all your funds from one place. Going for funds from different companies not only cuts down overlap but also makes your investments even more spread out.
Example of a Mutual Fund Portfolio Overlap
Understanding Mutual Fund overlapping is crucial for informed investment decisions. Let’s explore an example with Mutual Funds X and Y.
Suppose both funds have significant holdings in Tech Company A. The overlap is calculated by considering the shared stocks (counted twice) and dividing it by the total holdings in both X and Y.
For instance, if the overlap is 20%, it means 20% of the portfolios in both funds consist of the same stocks. This insight aids investors in diversifying their investments effectively and minimizing risks associated with overconcentration in specific assets.
In our example, recognizing the overlap helps investors assess the true diversity of their portfolio and make strategic adjustments for a well-balanced investment strategy. Understanding such overlaps is a powerful tool in optimizing your mutual fund investments. You can also use a mutual fund overlap calculator to calculate the mutual fund portfolio overlap tools.
Challenges of Mutual Fund Portfolio Overlap
When evaluating mutual fund portfolios, managing overlap is crucial for effective financial planning. Excessive overlap diminishes diversification, amplifies risk, and hinders the portfolio’s risk-mitigating potential.
For mutual fund investors, diversification isn’t achieved merely by adding more funds; it requires dissimilarity in strategy, portfolio content, and asset mix. Genuine diversification occurs when funds allocate across diverse asset classes.
Overlap amplifies overall portfolio losses during market downturns. While complete elimination is impractical, minimizing overlap is vital. To avoid overlap, scrutinize asset classes and specific stock/bond portfolios. Utilize publicly available fact sheets and comparative websites to assess overlap before investing, as it is important to check overlapping of mutual funds.
Is It Possible to Avoid Portfolio Overlap?
While achieving absolute zero mutual fund overlap can be quite challenging, there are strategies you can put into action to lessen it significantly. The key lies in diversification. Diversifying means spreading your investments across different kinds of assets – think stocks, bonds, real estate – and various sectors like IT, healthcare, and finance. This approach lowers the chances of having the same investments as others.
Furthermore, conducting your own research and exploring less mainstream stocks or niche sectors can uncover unique investment chances. Keeping a close eye on your portfolio and adjusting it when needed – like selling redundant investments and branching into other assets – can also help minimize overlap.
How to Identify Mutual Fund Portfolio Overlap?
To recognize Portfolio Overlap within Mutual Funds, investors undertake a thorough analysis of their fund holdings. Key steps include:
- Analysing Fund Holdings: Evaluate holdings across different Mutual Funds for common stocks, securities, or sectors.
- Quantitative Assessment: Use tools like correlation coefficients to measure overlap extent and assess concentration in specific stocks or sectors.
- Examining Fund Reports: Scrutinize detailed reports from Mutual Funds to identify common positions.
- Utilising Analytical Tools: Employ specialised software for portfolio analysis and comparison or explore financial databases for insights.
- Seeking Expert Consultation: Engage financial advisors for assistance in analysing Portfolio Overlap and diversifying across fund categories.
By effectively identifying Portfolio Overlap, investors can make informed decisions, strategically reallocate investments, and achieve a more diversified and balanced portfolio.
Should You Be Concerned About a Mutual Fund Portfolio Overlap?
As an investor, it is important to grasp the mutual fund portfolio overlap factor. You should also maintain a portfolio overlap check. For instance, index fund investments result in 100% mutual fund overlap due to shared underlying indexes. This factor changes dynamically, so focus on portfolio management outcomes, evaluating fund consistency and manager skills. When selecting mutual fund schemes, analyze various factors like age and income. Conduct thorough research before choosing any funds.
Why Diversify Your Mutual Fund Portfolio?
Diversifying your portfolio maximizes returns and mitigates risks by investing in different asset classes. While it doesn’t guarantee loss prevention, it minimizes losses. Essential for long-term investments, better diversification ensures downside protection and controls market volatility. By spreading investments, your overall portfolio isn’t significantly impacted if one asset class underperforms. Prioritize understanding fund investment goals and avoid overlap to prevent amplified losses.
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The real magic happens when you tailor your investment approach to match your unique goals and risk comfort. Yes, it is possible with smallcase. A smallcase is a basket of stocks/ETFs curated to reflect an idea that allows you to craft an investment portfolio tailored precisely to your personal goals and risk tolerance. This stands in contrast to just relying on off-the-shelf recommendations. While it might not be feasible to entirely eliminate overlap, these steps collectively empower you to shape a well-diversified portfolio that stands out uniquely.
To Wrap It Up…
Mutual fund portfolio overlap has the potential to hinder the advantages of diversification. While it might not be entirely eradicated, it’s crucial for investors to make proactive efforts in minimizing it. One effective approach is to spread investments across different fund categories and across various fund management companies.If you’re a mutual fund investor and would like to explore portfolio diversification options, then you can have a look at our curated portfolios at smallcase.
FAQs
The MF overlap or mutual fund overlap in a portfolio refers to the number of stocks along with their weights are common between two funds.
The acceptable amount of overlapping mutual funds depends on a number of factors, including your investment goals, risk tolerance, and time horizon. However, as a general rule of thumb, it is best to avoid mutual fund overlap more than 50%-60%.
You can know if mutual funds overlap by checking their portfolio holdings and stock weights. This is how to check mutual fund overlap. If two or more mutual funds have a significant number of the same securities in their portfolios, then they are overlapping. You can check mutual fund overlaps on the fund’s website or on an online financial portal.
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Overlap quantifies the commonality between portfolios. Take funds X & Y, where overlap is the count of shared stocks (double-counting them) divided by the total elements in both portfolios.
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