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 referred to as itself a large-cap fund however allotted important belongings in small-cap shares. In 2018, the Securities and Alternate 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 no less than 80% of their corpus solely within the prime 100 corporations by market capitalization. This modification by SEBI was necessary, nevertheless, it additionally amplified a priority for traders – Mutual Fund Overlap. The rules elevated the probabilities of portfolio overlap, notably 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 a lot of different the explanation why an overlap occurs, so it turns into important to trace and scale back it. Right here’s all it’s essential to learn about Mutual Fund Overlap and how one can hold it beneath management.
What’s Mutual Fund Overlap?
A mutual fund swimming pools cash from a lot of traders and invests the corpus in a basket of securities corresponding to shares, bonds, ETFs, REITs, or different belongings, relying on the fund’s funding technique. This is the reason mutual funds are identified for his or her diversification. Investing in varied funds additional expands this benefit and reduces threat.
However there are situations while you put money into a number of mutual funds, you would possibly find yourself proudly owning funds which have similar 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 suppose you’re investing in two utterly totally different funds, however in actuality, it’s possible you’ll be holding an analogous set of shares in each funds, which ends up in what known as a Mutual Fund Overlap. This manner, your portfolio turns into extra concentrated than you supposed.
Having a proportion of MF overlap is in fact widespread as fund managers will wish to put money into good corporations or shares with excessive potential. Nonetheless, a big overlap poses some critical dangers, crucial being the dilution of diversification. The objective of diversification is to unfold threat throughout varied securities, sectors, and asset lessons to minimise the influence of poor efficiency in any single space.
Even when a specific inventory or sector fails, the probability of your portfolio taking a nosedive will scale back considerably for those who diversify. A Mutual Fund Overlap compromises diversification. Chances are you’ll suppose 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 can assist 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 probably 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, although 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. Though 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 may be tremendously impacted, even for those who suppose you have got diversified your mutual fund portfolio by investing in a number of funds.
Varieties of Portfolio Overlap
Diversification is not only restricted to shares but additionally extends to sectors, industries, and international locations. It isn’t obligatory that market circumstances drive all these entities in the identical path. For instance, the buyer items trade may be performing nicely and, however, the auto trade is perhaps going through challenges on the similar time. Equally, some international locations is perhaps doing nicely, and a few economies is perhaps underperforming because of political causes.
Overlap may also lengthen past simply shares. The commonest type of portfolio overlap mutual fund is when a number of funds put money into the identical underlying securities, particularly shares. However there may be different varieties 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 trade or sector. For instance, a large-cap Fund A can make investments closely in banking because of the excessive market capitalisation of banks.
If you happen to additionally put money into one other mutual fund, Fund B, that focuses on blue-chip shares, it will probably even have important holdings within the banking sector. Which means that if the banking sector performs poorly each funds will undergo, resulting in increased threat in your portfolio. Equally, there may be an overlap based mostly on the type of investing. Two totally different funds, corresponding to 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 displaying excessive development potential.
Figuring out Portfolio Overlap in Mutual Funds
Listed below are a number of steps you’ll be able to take to determine the overlap in your mutual fund portfolio:
- Examine the mutual fund factsheet. A factsheet is a doc usually launched by AMCs that gives necessary details about a selected 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 during which the fund is invested. Taking a look in any respect the factsheets of the funds you’re invested in might 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.
- Alternatively, you need to use a web-based Mutual Fund Overlap device. That is the simplest strategy to test for overlap as all it’s essential to do is enter the related funds and the device provides you with an overlap proportion.
- Generally while you evaluation fund returns over totally different market cycles, you’ll be able to test for overlap. For instance, if the returns from two funds transfer in sync, it may imply they’ve comparable funding kinds or maintain most of the similar shares.
- You may at all times get skilled assist from an funding advisor to know the MF Overlap in your portfolio.
Instruments to Measure Mutual Fund Overlap
A web based Mutual Fund Overlap device makes figuring out and calculating the extent of overlap a lot simpler. All it’s essential 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 bought based mostly on the most recent knowledge, together with the overlapping securities and proportion of corpus allotted to them.
Totally different instruments provide totally different options. Some permit 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 Reduce Mutual Fund Overlap
As soon as your Mutual Fund Overlap, you’ll be able to take steps to cut back it. You doubtless gained’t have the ability to utterly get rid of 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 can provide 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 greatest to seek the advice of a monetary advisor about it. Listed below are the steps you’ll be able to take to cut back overlap:
- Diversify your mutual fund funding throughout totally different classes. Some classes are comparable, corresponding to large-cap, blue chip, and enormous and mid-cap funds. There’s a superb likelihood you’ll see important overlap within the shares held by these funds. To minimise this overlap, you’ll be able to think about going for funds from totally different classes, like small-cap and mid-cap development funds.
- Typically asset administration corporations have their very own funding philosophy which may result in overlap. Totally different schemes inside a fund home may also share the identical fund supervisor. Take into account investing throughout a greater diversity of fund homes.
- Examine earlier than you make investments. The data on a portfolio’s holdings is available on apps or in actual fact sheets, so this course of is sort of simple. The portfolio composition additionally adjustments usually as fairness funds are actively managed, so it’s greatest to control the adjustments and rebalance accordingly.
- Discuss to an funding advisor who can assess your monetary scenario and create a well-diversified and balanced portfolio that can be sure you are usually not overexposed to a handful of securities.
Portfolio Overlap vs. Diversification
Portfolio overlap is principally a side-effect of diversification. It might probably solely occur while you put money into no less than two totally different schemes. Listed below are a few key variations between the 2:
| Issue | Portfolio Overlap | Mutual Fund Diversification |
| What It Means | Overlap occurs when two or extra funds in your mutual fund portfolio put money into the identical securities, typically shares. | Diversification is the method of spreading mutual fund investments throughout totally different classes of funds. |
| Danger | Vital overlap can enhance threat, as a result of primarily even if you’re invested in a number of funds, their underlying shares are the identical and the good thing about diversification has diminished. | The objective of diversification is to cut back threat in order that if one asset underperforms, the opposite belongings in your portfolio might help cushion the influence. |
Conclusion
There are many instruments on-line that may assist you to calculate your portfolio overlap. A decrease portfolio overlap is healthier for diversification, nevertheless it shouldn’t be the one consideration when deciding on a fund. In your quest to cut back Mutual Fund Overlap, it’s necessary to keep in mind that a small quantity of overlap is completely acceptable. You gained’t have the ability to get rid of it utterly, and making an attempt to take action can lead you to decide on funds that don’t align along with your monetary targets, threat tolerance, and funding horizon.
Your targets ought to at all times take precedence, so be sure that the aims of the fund you select match your personal. It’s additionally necessary to evaluation your portfolio usually. 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.