Introduction

Mutual funds have become a preferred method for many investors. They are an easy way to engage with the market and achieve exposure across varied purchasing opportunities. The drawback is when you take your eye off your portfolio, you may encounter something called mutual fund overlap. Over time, mutual fund overlap erodes the diversification you want to achieve, which can expose your investments when you do not want them to be exposed—typically in down markets.

So, what is Mutual Fund Overlap, and How Do You Avoid it? Let's look into the steps to keep your portfolio in the right area.

What is Mutual Fund Overlap?

Imagine you have invested in a couple of mutual funds to better frame your investments across several different avenues. Looking closer, you see they are holding a larger proportion of the same stocks or bonds. Mutual fund overlap is when multiple funds in your portfolio bet on the same companies or sectors. Instead of diversifying your risk, you’re doubting down on the same bets.

Take large-cap funds, for example. With dozens of options, it’s easy to assume two funds will give you twice the variety. While you might think you follow two different mutual funds, they're likely both heavily invested in some of the same companies—think big names like Reliance Industries and Infosys. Sure, the funds may be differently named, but your exposures are about the same. So, any diversification benefits you thought you were getting are reduced if any of the companies you hold drop in value simultaneously.

Why Overlap in Your Mutual Fund Can Hurt You

At Motilal Oswal, we believe that building a portfolio of mutual funds can be easy and efficient. Overlap defeats that purpose.

Here are why these matters: -

Lack of Diversification

If your fund holds shares of the same stocks, you aren't creating any diversification throughout the market. It means you're stuck in the lower left corner of the risk/reward spectrum—not free to find different things to invest in.

Greater Risks

When your investments are loaded with the same stocks or same sectors, and those stocks/sectors decline or get hit with bad news—those risks become concentrated. Like the cliché—you're putting all your eggs in one basket and don't even know it.

Missed Gains

You might skip out on growth in other market areas by sticking to similar funds. A more varied portfolio could catch those extra wins you leave on the table.

Extra Costs

Holding funds that mirror each other means you’re paying management fees for the same thing twice. Those costs add up, nibbling away at your returns over time.

How to Spot Overlap in Your Portfolio

The good news? You don’t need to be a financial wizard to determine if overlap creeping into your investments. Here are some simple ways to check:

1. Dig Into the Holdings: Pull up the fact sheets for your funds and compare their top holdings. You've got overlap if you see repeats—like HDFC Bank popping up in your equity and multi-cap funds.

2. Focus on the Big Players: Most funds list their top 10 investments. If those lists look eerily similar across your funds, it’s a red flag. 

3. Use Smart Tools: Platforms like Morningstar’s Portfolio X-Ray can do the heavy lifting for you. They analyse your holdings and highlight where your funds are stepping on each other’s toes. At Motilal Oswal, we also offer tools to help you see your portfolio clearly—because clarity is power.

4. Chat with an Advisor: If numbers aren’t your thing, our financial experts can spot overlaps and suggest tweaks to balance your portfolio.

To get technical for a second, you can calculate overlap by dividing the number of shared stocks between two funds by the total unique stocks across both. A high percentage means your funds are more alike than different—not ideal if variety is your goal.

How to Keep Overlap at Bay

Building a diverse and resilient portfolio takes a little planning, but it’s worth it. Here’s how you can dodge overlap and keep your investments working for you:

1. Mix Up Your Funds: Don’t just stick to one type. Blend large-cap, mid-cap, or even sector-specific funds based on what you’re aiming for. For instance, adding a small-cap fund to your large-cap mix spreads your risk and taps into different growth pockets.

2. Check Holdings Regularly: Look at a fund’s holdings before investing. If your growth fund and value fund both love Tata Motors, maybe swap one for something fresher.

3. Rebalance When Needed: Markets change, and your portfolio should, too. A brief review every few months is all it takes to ensure your mix of assets align with your goals and eliminate undesired duplications.

4. Pick Funds with a Twist: Choose funds using distinct strategies. For instance, pair a fund that seeks growth with a fund that looks for undervalued stocks—making it less likely they will pursue the same undiscovered gems.

Wrapping It Up

Your investments should represent your goals—not hinder them. A little overlap in mutual funds may seem benign, but it could functionally reduce the diversification you need and rely upon. You can better manage risks and returns by being inquisitive about your investments, accessing the appropriate tools, and adjusting when needed.

Take a moment today to glance at your portfolio. Are your funds playing too nice with each other? A little effort now can make a big difference—ensuring your money’s working as hard as you do.

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