How overlapping mutual funds reduce your returns and what to do about it

If you are a smart investor, you likely understand the value of diversification. But there is a hidden trap many overlook, i.e., mutual fund overlap. It can quietly undo your diversification efforts and limit your portfolio’s true potential.

By the end of the blog, you will know that simply holding units in different mutual funds does not enable one to grow their wealth optimally. To create a truly diversified and dynamic passive income source, you should learn how to avoid MF overlap. 

Key Takeaways

• Mutual fund overlap occurs when two or more funds in a person’s portfolio hold the same underlying stocks. 
• Overlapping reduces the benefits of diversification, making your portfolio more vulnerable to poor market performance.
• To reduce overlap, you must regularly check the top holdings of your funds, use online mutual fund overlap tools and compare fund categories.

What is Overlap in Mutual Funds?

A portfolio overlap can occur when you invest in mutual funds that have the same underlying stocks or are invested in similar sectors. This creates a false sense of diversification, as the different funds you have invested in actually hold quite similar assets.

Let’s say you decide to invest in two separate large-cap funds. After several months, you notice that the top holdings of both these funds are HDFC Bank, ICICI Bank, and Axis Bank. This directly indicates that your portfolio needs a thorough mutual fund overlap checking and rectification. 

How Overlapping in Your Mutual Fund Portfolio Can Affect Overall Returns? 

Many investors assume that holding multiple mutual funds ensures diversification. However, if those funds have overlapping holdings, especially in the same top-performing stocks, your portfolio may be less diversified than you think. This is where a mutual fund overlap tool becomes essential.

For instance, if you put your money into both the SBI Bluechip Fund and the HDFC Top 100 Fund, you could find that around 40% of your investment is tied up in just three companies: HDFC Bank, Reliance Industries, and Infosys. 

If those stocks do not perform well, your whole portfolio can take a hit. Conversely, if you had selected funds with more varied holdings, this situation could have been avoided.  

Plus, this mutual fund overlap means you are paying higher fees without actually getting any extra diversification. It increases your overall risk and you end up lowering your overall returns.

What are Some Additional Risks of Mutual Fund Overlap?

Investment portfolios tend to get riskier when you do not compare the underlying stocks of chosen mutual funds. These are some problems that typically arise:

Concentration Risk

As you skip using an online mutual fund overlap calculator, it leads to investments in similar types of securities. Thus, if one fund goes down in price, you suffer greater losses in your portfolio. For instance, if four of your mutual funds heavily invest in the same stock, and that stock falls, your portfolio will suffer significant losses.

Reduced Diversification

A portfolio overlap across multiple funds restricts the overall diversification. As this limits the spread of risk, you may face higher losses in a bearish market. 

Higher Expense Ratios 

There is an expense ratio attached to every mutual fund, which includes fees like the management fee. Failure to compare mutual fund holdings before investing can lead to redundant charges and increased overall costs.

More Difficult Rebalancing and Asset Allocation

The redundancy from an overlap forces investors to coordinate multiple fund adjustments simultaneously. They must do so to maintain target allocations, which increases operational complexity and the risk of unintended portfolio drift.

Strategies to Identify Overlaps in Mutual Funds 

After going through the instructions given below, you will understand how to complete a mutual fund overlap checking properly:

Check the Top Holdings: Every wise investor should closely examine the top holdings of each mutual fund in their portfolio. By reviewing fund factsheets or portfolio disclosures, you can easily identify overlapping stocks or sectors, and clear signs of reduced diversification.

Use an Online Mutual Fund Overlap Calculator: Alternatively, you can use online mutual fund overlap tools and enter the names of your funds. These handy tools will automatically compare the portfolios, calculate how much of the holdings overlap, and show you the common stocks.

Check the Category: When comparing your mutual funds, consider their categories, like large-cap, mid-cap, or sector-specific funds. Funds that fall into the same category are more likely to share overlapping holdings. 

How to Reduce Your Mutual Fund Portfolio Overlap? 

Make sure to conduct a thorough analysis of your portfolio by looking at fund objectives, sector allocations, and the overall mix of assets. This helps you maintain diversification and steer clear of too much exposure to specific stocks or sectors.

Next, you can follow these strategies to steer clear of a mutual fund overlap:

• If you have detected signs of overlapping, limit the number of funds.
• Additionally, avoid funds that have similar benchmarks.
• Finally, you should review your portfolio at regular intervals. You can use an online mutual fund overlap tool to make the job easier. 

Final Words:

Mutual fund overlap can undermine the very purpose of diversification, making your portfolio more vulnerable and less efficient. To avoid its adverse effects, it is suggested to follow smart investing practices and regularly review your fund holdings. The tips shared in this blog can help you build a more balanced, growth-oriented investment strategy.

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