Mutual Fund Overlap: How It Impacts Your Portfolio

Earlier than 2018, totally different Asset Administration Corporations (AMCs) had their very own definition of what constituted a large-cap, mid-cap, or small-cap fund. A fund could have known as itself a large-cap fund however allotted important 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 totally different asset administration corporations could be uniform.

For instance, now large-cap mutual funds have to take a position at the very least 80% of their corpus solely within the high 100 corporations by market capitalization. This alteration by SEBI was necessary, nevertheless, 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 if you’re holding a number of mutual funds, your fund portfolio could also be missing in diversification. There are various different explanation why an overlap occurs, so it turns into important to trace and cut back it. Right here’s all you’ll want to learn about Mutual Fund Overlap and how one can maintain it below management.

What’s Mutual Fund Overlap?

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

However there are cases if you put money into a number of mutual funds, you would possibly 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 would possibly assume you’re investing in two utterly totally different funds, however in actuality, it’s possible you’ll be holding the same set of shares in each funds, which leads to what known as a Mutual Fund Overlap. This manner, your portfolio turns into extra concentrated than you meant.

Having a share of MF overlap is in fact widespread as fund managers will wish to put money into good corporations or shares with excessive potential. Nevertheless, a major overlap poses some severe dangers, an important being the dilution of diversification. The purpose of diversification is to unfold threat throughout numerous securities, sectors, and asset lessons to minimise the impression of poor efficiency in any single space.

Even when a selected inventory or sector fails, the probability of your portfolio taking a nosedive will cut back considerably for those who diversify. A Mutual Fund Overlap compromises diversification. You could assume you might be spreading threat 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 show you how 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 totally different names and presumably totally 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 widespread, despite the fact that their weightage just isn’t 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 important positions in HDFC Financial institution. Fund A has allotted 7%, and Fund B has allotted 6% to it. Although they’re two totally 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 nicely, your returns could be vastly impacted, even for those who assume you’ve diversified your mutual fund portfolio by investing in a number of funds.

Sorts of Portfolio Overlap

Diversification isn’t just restricted to shares but in addition extends to sectors, industries, and international locations. It isn’t vital that market situations pressure all these entities in the identical path. For instance, the buyer items business could be performing nicely and, alternatively, the car business may be dealing with challenges on the similar time. Equally, some international locations may be doing nicely, and a few economies may be underperforming because of political causes.

Overlap may also prolong past simply shares. The most typical sort of portfolio overlap mutual fund is when a number of funds put money into the identical underlying securities, particularly shares. However there could be different kinds of MF Overlap that 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 because of the excessive market capitalisation of banks.

In case you additionally put money into one other mutual fund, Fund B, that focuses on blue-chip shares, it might probably even have important holdings within the banking sector. Which means that if the banking sector performs poorly each funds will undergo, resulting in greater threat in your portfolio. Equally, there could be an overlap based mostly on the type of investing. Two totally different funds, reminiscent of a mid-cap development fund and a small-cap development fund would possibly put money into 3 or 4 similar shares as a result of these corporations are exhibiting excessive development potential.

Figuring out Portfolio Overlap in Mutual Funds

Listed below are a couple of steps you possibly can take to determine the overlap in your mutual fund portfolio:

1. Test the mutual fund factsheet. A factsheet is a doc repeatedly launched by AMCs that gives necessary 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 through which the fund is invested. Taking a look in any respect the factsheets of the funds you’re invested in will help you assess whether or not there’s any overlap with different funds in your portfolio. You may obtain the related truth sheets from AMC web sites.
2. Alternatively, you need to use a web-based Mutual Fund Overlap device. That is the best strategy to verify for overlap as all you’ll want to do is enter the related funds and the device will provide you with an overlap share.
3. Typically if you overview fund returns over totally different market cycles, you possibly can verify for overlap. For instance, if the returns from two funds transfer in sync, it may imply they’ve related funding types or maintain most of the similar shares.
4. You may all the time 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 you’ll want to 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 obtained based mostly on the newest knowledge, together with the overlapping securities and share of corpus allotted to them.

Totally different instruments provide totally different options. Some will let you enter 4 mutual funds, whereas some solely provide two. Morningstar PM and Worth Analysis are two choices you possibly can look into to calculate the overlap in your portfolio. Do notice 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 possibly can take steps to cut back it. You seemingly gained’t be capable 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 okay? There isn’t a strict rule for this, so it will be greatest to seek the advice of a monetary advisor about it. Listed below are the steps you possibly can take to cut back overlap:

1. Diversify your mutual fund funding throughout totally different classes. Some classes are related, reminiscent of large-cap, blue chip, and huge and mid-cap funds. There’s a great likelihood you’ll see important overlap within the shares held by these funds. To minimise this overlap, you possibly can take into account going for funds from totally different classes, like small-cap and mid-cap development funds.
2. Usually asset administration corporations have their very own funding philosophy which might result in overlap. Totally different schemes inside a fund home may also share the identical fund supervisor. Take into account investing throughout a greater variety of fund homes.
3. Test earlier than you make investments. The data on a portfolio’s holdings is available on apps or in reality sheets, so this course of is sort of straightforward. The portfolio composition additionally modifications repeatedly as fairness funds are actively managed, so it’s greatest to control the modifications 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 ensure you should 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 at the very least two totally different schemes. Listed below are a few key variations between the 2:

Conclusion

There are many instruments on-line that may show you how to calculate your portfolio overlap. A decrease portfolio overlap is best for diversification, but it surely shouldn’t be the one consideration when deciding on a fund. In your quest to cut back Mutual Fund Overlap, it’s necessary to do not forget that a small quantity of overlap is completely acceptable. You gained’t be capable 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 objectives, threat tolerance, and funding horizon. 

Your objectives ought to all the time take precedence, so ensure that the aims of the fund you select match your personal. It’s additionally necessary to overview your portfolio repeatedly. The holdings of a fund change continuously, so you will need to make changes to make sure that the portfolio overlap stays at a suitable stage.