Mutual funds are a popular choice for investors looking to diversify their portfolios and achieve their financial goals. However, in the world of mutual funds, a phenomenon called "mutual fund overlap" can affect your investments. This article explores the concept of mutual fund overlap, why it occurs, and how to address it effectively.
What is mutual fund overlap?
Mutual fund overlap, simply put, is the presence of the same or similar securities across different mutual fund schemes. It happens when multiple mutual funds hold positions in identical or comparable securities within their portfolios. While some degree of overlap is expected due to market conditions, excessive overlap can lead to unintended concentration of risk.
What is the meaning of portfolio overlap in mutual funds?
Mutual fund portfolio overlap refers to the similarity in holdings or securities between different mutual fund schemes. When two or more funds have a substantial portion of their portfolios invested in the same stocks, bonds or other assets, it creates a situation of portfolio overlap. This situation can impact the diversification benefits that mutual funds are known for.
Understand mutual fund portfolio overlap with an example
Consider this scenario: Imagine an investor puts money into two separate mutual funds. If these funds both invest in the same company, it creates a portfolio overlap. Consequently, if one fund plummet in value, the investor stands to lose money, as their portfolios mirror each other.
Understanding diversification can pose a challenge for many investors. Simply investing in multiple funds does not automatically ensure diversification. To truly mitigate risk, investors must cultivate a diversified investment portfolio devoid of overlap.
What are the causes of mutual fund overlap?
While there might be many different reasons for portfolio overlap to occur, here are a few major reasons listed:
- Benchmark Tracking: Many mutual funds aim to mimic a specific market index or benchmark. As a result, they may invest in the same stocks as those present in the benchmark.
- Sectoral Focus: Funds focusing on specific sectors or industries are likely to have overlapping holdings. For instance, technology sector funds may invest in similar tech companies.
- AMC or Fund Manager’s investment style or choices: Investment decisions made by fund managers can lead to overlap if they favour similar stocks or sectors.
- Following the hot trends: Imagine everyone's buzzing about green energy companies. This excitement can lead many mutual funds to invest in these same stocks. As a result, even if you choose different funds, they might hold similar assets, reducing the diversification benefit.
- Similar investment styles: Fund managers may be influenced by the same market trends or data, leading them to make similar investment choices. Additionally, they might follow popular investment strategies, causing overlap across different funds.