Investing in mutual funds can be a powerful way to grow your wealth over time, but it’s essential to understand the dynamics at play within your investment portfolio. One critical factor to consider is mutual fund overlap, which occurs when multiple funds hold similar securities or assets.
In this article, we’ll delve into the concept of mutual fund overlap, its prevalence across different fund categories, its impact on portfolio diversification, and strategies to optimize your investment approach.
Mutual Fund Overlap
Let’s start with some numbers to put things into perspective. Imagine an investor who has invested in a total of 93 mutual fund schemes. On average, investors typically hold around 30 schemes when they initially engage in a discovery call with financial advisors. However, what’s interesting to note is that 54% of the entire equity mutual fund Assets Under Management (AUM) is invested in the Nifty50 stocks alone.
What is Mutual Fund Overlap?
Mutual fund overlap occurs when two or more funds within a portfolio hold a portion of the same securities or assets. This overlap can occur within the same fund category or even across different categories. For example, two large-cap funds might hold shares of the same company, leading to overlap.
Prevalence of Mutual Fund Overlap
The prevalence of mutual fund overlap varies across different fund categories. In large-cap funds, which are mandated to invest at least 80% of their assets in the top 100 stocks by market capitalization, the average overlap between schemes is around 47%. For instance, the overlap between the HDFC Top 100 Fund and the ICICI Prudential Bluechip Fund is as high as 58%. In other categories such as ELSS and Flexi caps, the average overlap can range from 30% to over 50%.
Impact of Mutual Fund Overlap
Mutual fund overlap can have significant implications for portfolio diversification and performance. While the goal of investing across multiple funds is to diversify risk, overlapping holdings can compromise this objective. When a particular set of stocks underperforms, it affects all overlapping funds significantly, amplifying the risk of underperformance in the portfolio as a whole.
Optimizing Your Investment Strategy
Given the prevalence and impact of mutual fund overlap, it’s crucial to optimize your investment strategy to minimize risks and maximise returns. One approach is to focus on index funds or ETFs that track broad market indices like the Nifty50 for large-cap holdings. By doing so, you can effectively capture the performance of the overall market while reducing overlap and management fees associated with actively managed funds.
How to calculate Mutual fund Overlap?
Over the internet, you may find some of the mutual fund overlap calculators. You can use them for better investment decisions and analysis.
How many mutual funds to invest?
It depends on your comfort level and knowledge of the market. For most investors,
- Large Cap Mutual Funds: Stick to 1 or 2 to avoid overlap in holdings.
- Mid Cap Mutual Funds: Limit yourself to 1 or 2 due to higher risk.
- Small Cap Mutual Funds: Keep it to 1 or 2 to manage risk, especially since they are highly volatile.
- Debt Funds: Aim for 1, but having 2 is reasonable as they generally offer similar returns.
- Sectoral Mutual Funds: Invest only in sectors you understand well; 1 or 2 may suffice.
Overall, a total of around 5 to 8 mutual funds could be a good balance, but feel free to adjust based on your expertise and risk tolerance.
Mutual fund overlap is a common phenomenon that investors need to be aware of when constructing their investment portfolios. By understanding the prevalence, impact, and strategies to mitigate overlap, investors can optimise their investment approach for better diversification and long-term performance.
Remember, the goal is not just to invest in multiple funds but to ensure that each fund adds unique value to your portfolio.
Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. The information is based on various secondary sources on the internet and is subject to change. Please consult with a financial expert before making investment decisions.
