Mutual Fund Overlap: How It Impacts Your Portfolio

Earlier than 2018, completely different Asset Administration Firms (AMCs) had their very own definition of what constituted a large-cap, mid-cap, or small-cap fund. A fund could have referred to as itself a large-cap fund however allotted vital belongings in small-cap shares. In 2018, the Securities and Change Board of India (SEBI) issued pointers for classifying mutual funds into large-cap, mid-cap, and small-cap classes to make issues extra clear and constant, so the classification of mutual fund schemes throughout completely different asset administration corporations can be uniform.

For instance, now large-cap mutual funds have to take a position not less than 80% of their corpus solely within the high 100 corporations by market capitalization. This transformation by SEBI was vital, nonetheless, it additionally amplified a priority for buyers – Mutual Fund Overlap. The rules elevated the possibilities of portfolio overlap, significantly amongst large-cap and mid-cap funds. Since all large-cap mutual funds are required to put money into the identical pool of the highest 100 corporations, many mutual funds find yourself holding the identical shares.

That’s proper. Even in case you are holding a number of mutual funds, your fund portfolio could also be missing in diversification. There are lots of different explanation why an overlap occurs, so it turns into important to trace and scale back it. Right here’s all that you must find out about Mutual Fund Overlap and how one can preserve it beneath management.

What’s Mutual Fund Overlap?

A mutual fund swimming pools cash from numerous buyers and invests the corpus in a basket of securities equivalent to shares, bonds, ETFs, REITs, or different belongings, relying on the fund’s funding technique. This is the reason mutual funds are identified for his or her diversification. Investing in varied funds additional expands this benefit and reduces danger.

However there are situations if you put money into a number of mutual funds, you may find yourself proudly owning funds which have an identical holdings. For instance, think about you maintain two mutual funds – Fund A and Fund B. In Fund A the supervisor has allotted 10% of the fund’s holdings to Inventory X and Y, and in Fund B, Inventory X and Y take up 8% of the portfolio. You may assume you’re investing in two utterly completely different funds, however in actuality, it’s possible you’ll be holding an identical set of shares in each funds, which ends up in what is known as a Mutual Fund Overlap. This fashion, your portfolio turns into extra concentrated than you supposed.

Having a share of MF overlap is after all frequent as fund managers will wish to put money into good corporations or shares with excessive potential. Nevertheless, a big overlap poses some severe dangers, crucial being the dilution of diversification. The objective of diversification is to unfold danger throughout varied securities, sectors, and asset courses to minimise the affect of poor efficiency in any single space.

Even when a selected inventory or sector fails, the chance of your portfolio taking a nosedive will scale back considerably in the event you diversify. A Mutual Fund Overlap compromises diversification. You could assume you might be spreading danger by investing in a number of SIPs, however the hidden overlap will defeat the aim of diversification.

Perceive mutual fund portfolio overlap with an instance

Right here’s a quite simple instance that may provide help to perceive how portfolio overlap mutual funds works. Suppose a person invests in two funds. Fund A is a large-cap fund, and Fund B is a blue chip fund. At first look, a brand new investor might imagine that they’re diversifying their investments as a result of the funds have completely different names and presumably completely different funding methods. When the investor seems on the holdings of every fund, they discover that there are some shares that each funds have in frequent, although their weightage is just not the identical. 

For instance, Fund A has 8% in Reliance Industries and Fund B has invested 10% in the identical inventory. On high of that each funds additionally maintain vital positions in HDFC Financial institution. Fund A has allotted 7%, and Fund B has allotted 6% to it. Though they’re two completely different funds, there’s some inventory overlap between them.

An overlap of mutual funds implies that there are particular sectors, industries, or shares that you’re overexposed to. In the event that they don’t carry out properly, your returns might be significantly impacted, even in the event you assume you might have diversified your mutual fund portfolio by investing in a number of funds.

Forms of Portfolio Overlap

Diversification isn’t just restricted to shares but additionally extends to sectors, industries, and international locations. It isn’t needed that market situations drive all these entities in the identical course. For instance, the patron items business might be performing properly and, however, the car business is likely to be dealing with challenges on the similar time. Equally, some international locations is likely to be doing properly, and a few economies is likely to be underperforming attributable to political causes.

Overlap can even prolong past simply shares. The most typical type of portfolio overlap mutual fund is when a number of funds put money into the identical underlying securities, particularly shares. However there might be different kinds of MF Overlap which will or not be as simply detected. One such overlap is sector overlap, the place funds make investments closely in the identical business or sector. For instance, a large-cap Fund A can make investments closely in banking as a result of excessive market capitalisation of banks.

In the event you additionally put money into one other mutual fund, Fund B, that focuses on blue-chip shares, it may well even have vital holdings within the banking sector. Because of this if the banking sector performs poorly each funds will endure, resulting in greater danger in your portfolio. Equally, there might be an overlap primarily based on the fashion of investing. Two completely different funds, equivalent to a mid-cap progress fund and a small-cap progress fund may put money into 3 or 4 similar shares as a result of these corporations are exhibiting excessive progress potential.

Figuring out Portfolio Overlap in Mutual Funds

Listed below are just a few steps you’ll be able to take to determine the overlap in your mutual fund portfolio:

1. Verify the mutual fund factsheet. A factsheet is a doc repeatedly launched by AMCs that gives vital details about a particular mutual fund scheme. In it, you’ll discover a part devoted to the composition of the portfolio, which particulars the fund’s present holdings, just like the shares or bonds within the portfolio, their weightages, and the sectors during which the fund is invested. Taking a look in any respect the factsheets of the funds you’re invested in can assist you assess whether or not there’s any overlap with different funds in your portfolio. You’ll be able to obtain the related reality sheets from AMC web sites.
2. Alternatively, you should use an internet Mutual Fund Overlap device. That is the best approach to test for overlap as all that you must do is enter the related funds and the device gives you an overlap share.
3. Typically if you evaluation fund returns over completely different market cycles, you’ll be able to test for overlap. For instance, if the returns from two funds transfer in sync, it might imply they’ve comparable funding types or maintain most of the similar shares.
4. You’ll be able to at all times get skilled assist from an funding advisor to grasp the MF Overlap in your portfolio.

Instruments to Measure Mutual Fund Overlap

An internet Mutual Fund Overlap device makes figuring out and calculating the extent of overlap a lot simpler. All that you must do is choose the fund class and the related schemes and hit calculate. The device will present you precisely how a lot mutual fund portfolio overlap you’ve received primarily based on the most recent knowledge, together with the overlapping securities and share of corpus allotted to them.

Completely different instruments supply completely different options. Some help you enter 4 mutual funds, whereas some solely supply two. Morningstar PM and Worth Analysis are two choices you’ll be able to look into to calculate the overlap in your portfolio. Do be aware that you could be want a subscription to view the outcomes of the overlapping securities and weightages.

Methods to Decrease Mutual Fund Overlap

As soon as you already know your Mutual Fund Overlap, you’ll be able to take steps to cut back it. You possible gained’t have the ability to utterly remove it as a result of many large-cap funds put money into dependable performers to various levels. Equally, you’ll discover small-cap fund managers investing in the identical high-potential shares that they consider may give excessive returns. A query arises right here. Simply how a lot overlap is ok? There isn’t a strict rule for this, so it could be greatest to seek the advice of a monetary advisor about it. Listed below are the steps you’ll be able to take to cut back overlap:

1. Diversify your mutual fund funding throughout completely different classes. Some classes are comparable, equivalent to large-cap, blue chip, and enormous and mid-cap funds. There’s a great probability you’ll see vital overlap within the shares held by these funds. To minimise this overlap, you’ll be able to think about going for funds from completely different classes, like small-cap and mid-cap progress funds.
2. Usually asset administration corporations have their very own funding philosophy which may result in overlap. Completely different schemes inside a fund home can even share the identical fund supervisor. Contemplate investing throughout a greater variety of fund homes.
3. Verify earlier than you make investments. The data on a portfolio’s holdings is available on apps or in truth sheets, so this course of is kind of straightforward. The portfolio composition additionally adjustments repeatedly as fairness funds are actively managed, so it’s greatest to keep watch over the adjustments and rebalance accordingly.
4. Discuss to an funding advisor who can assess your monetary scenario and create a well-diversified and balanced portfolio that may be sure to are usually not overexposed to a handful of securities.

Portfolio Overlap vs. Diversification

Portfolio overlap is principally a side-effect of diversification. It may possibly solely occur if you put money into not less than two completely different schemes. Listed below are a few key variations between the 2:

Conclusion

There are many instruments on-line that may provide help to calculate your portfolio overlap. A decrease portfolio overlap is healthier for diversification, however it shouldn’t be the one consideration when choosing a fund. In your quest to cut back Mutual Fund Overlap, it’s vital to keep in mind that a small quantity of overlap is completely acceptable. You gained’t have the ability to remove it utterly, and making an attempt to take action can lead you to decide on funds that don’t align together with your monetary targets, danger tolerance, and funding horizon. 

Your targets ought to at all times take precedence, so guarantee that the goals of the fund you select match your individual. It’s additionally vital to evaluation your portfolio repeatedly. The holdings of a fund change continually, so you will need to make changes to make sure that the portfolio overlap stays at an appropriate degree.