Mutual Fund Overlap: How It Impacts Your Portfolio

Earlier than 2018, totally 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 important belongings in small-cap shares. In 2018, the Securities and Trade 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 speculate a minimum of 80% of their corpus solely within the prime 100 corporations by market capitalization. This variation by SEBI was necessary, nonetheless, it additionally amplified a priority for traders – Mutual Fund Overlap. The rules elevated the probabilities of portfolio overlap, significantly amongst large-cap and mid-cap funds. Since all large-cap mutual funds are required to spend money on 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 lots of 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 find out about Mutual Fund Overlap and how one can hold it below management.

What’s Mutual Fund Overlap?

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

However there are cases once you spend money on 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 fully totally different funds, however in actuality, chances are you’ll be holding an identical set of shares in each funds, which leads to what is named a Mutual Fund Overlap. This manner, your portfolio turns into extra concentrated than you meant.

Having a proportion of MF overlap is in fact frequent as fund managers will wish to spend money on good corporations or shares with excessive potential. Nevertheless, a big overlap poses some critical dangers, an important being the dilution of diversification. The aim of diversification is to unfold threat throughout numerous securities, sectors, and asset courses to minimise the influence 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 if you happen to diversify. A Mutual Fund Overlap compromises diversification. It’s possible you’ll assume you’re 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 allow you 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 to be on the holdings of every fund, they discover that there are some shares that each funds have in frequent, 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 prime 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. Despite the fact that 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 effectively, your returns could be significantly impacted, even if you happen to 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 in addition extends to sectors, industries, and international locations. It isn’t mandatory that market situations power all these entities in the identical route. For instance, the patron items business could be performing effectively and, then again, the auto business is likely to be going through challenges on the identical time. Equally, some international locations is likely to be doing effectively, and a few economies is likely to be underperforming attributable to political causes.

Overlap may also prolong past simply shares. The commonest type of portfolio overlap mutual fund is when a number of funds spend money on the identical underlying securities, particularly shares. However there could be different varieties 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 because of the excessive market capitalisation of banks.

In case you additionally spend money on one other mutual fund, Fund B, that focuses on blue-chip shares, it might even have important holdings within the banking sector. Because of this if the banking sector performs poorly each funds will undergo, resulting in increased threat in your portfolio. Equally, there could be an overlap based mostly on the fashion of investing. Two totally different funds, similar to a mid-cap progress fund and a small-cap progress fund would possibly spend money on 3 or 4 identical shares as a result of these corporations are displaying excessive progress potential.

Figuring out Portfolio Overlap in Mutual Funds

Listed here are a number of steps you’ll be able to take to establish the overlap in your mutual fund portfolio:

1. Examine the mutual fund factsheet. A factsheet is a doc usually 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 by which the fund is invested. Taking a look in any respect the factsheets of the funds you’re invested in may help you assess whether or not there’s any overlap with different funds in your portfolio. You possibly can obtain the related reality sheets from AMC web sites.
2. Alternatively, you should utilize an internet Mutual Fund Overlap instrument. That is the best method to verify for overlap as all you’ll want to do is enter the related funds and the instrument will provide you with an overlap proportion.
3. Generally once you evaluate fund returns over totally different market cycles, you’ll be able to verify for overlap. For instance, if the returns from two funds transfer in sync, it may imply they’ve related funding kinds or maintain most of the identical shares.
4. You possibly can 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 instrument 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 instrument will present you precisely how a lot mutual fund portfolio overlap you’ve received based mostly on the most recent knowledge, together with the overlapping securities and proportion of corpus allotted to them.

Completely different instruments provide totally different options. Some assist you to enter 4 mutual funds, whereas some solely provide 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 recognize your Mutual Fund Overlap, you’ll be able to take steps to scale back it. You doubtless received’t be capable to fully get rid of it as a result of many large-cap funds spend money on dependable performers to various levels. Equally, you’ll discover small-cap fund managers investing in the identical high-potential shares that they imagine 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 will be finest to seek the advice of a monetary advisor about it. Listed here are the steps you’ll be able to take to scale back overlap:

1. Diversify your mutual fund funding throughout totally different classes. Some classes are related, similar to large-cap, blue chip, and huge and mid-cap funds. There’s a superb probability you’ll see important overlap within the shares held by these funds. To minimise this overlap, you’ll be able to contemplate going for funds from totally different classes, like small-cap and mid-cap progress funds.
2. Usually asset administration corporations have their very own funding philosophy which might result in overlap. Completely different schemes inside a fund home may also share the identical fund supervisor. Think about investing throughout a greater diversity of fund homes.
3. Examine earlier than you make investments. The knowledge on a portfolio’s holdings is available on apps or the truth is sheets, so this course of is sort of simple. The portfolio composition additionally adjustments usually as fairness funds are actively managed, so it’s finest to control the adjustments and rebalance accordingly.
4. Discuss to an funding advisor who can assess your monetary state of affairs and create a well-diversified and balanced portfolio that may be sure to should not overexposed to a handful of securities.

Portfolio Overlap vs. Diversification

Portfolio overlap is mainly a side-effect of diversification. It could solely occur once you spend money on a minimum of two totally different schemes. Listed here are a few key variations between the 2:

Conclusion

There are many instruments on-line that may allow you to calculate your portfolio overlap. A decrease portfolio overlap is best for diversification, however it shouldn’t be the one consideration when choosing a fund. In your quest to scale back Mutual Fund Overlap, it’s necessary to keep in mind that a small quantity of overlap is completely acceptable. You received’t be capable to get rid of it fully, and making an attempt to take action can lead you to decide on funds that don’t align along with your monetary objectives, threat tolerance, and funding horizon. 

Your objectives ought to all the time take precedence, so be sure that the goals of the fund you select match your individual. It’s additionally necessary to evaluate your portfolio usually. The holdings of a fund change consistently, so you will need to make changes to make sure that the portfolio overlap stays at an appropriate stage.