Jasmine Birtles
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Mutual fund overlaps are something many investors don’t even notice. But you should. Investors invest in multiple funds to diversify their portfolios, but sometimes, these funds have similar strategies or stock portfolios and end up with overlapping securities. Although not a big issue, mutual fund overlap can defeat the purpose of diversification.
Investors have multiple mutual fund schemes or investments with different Asset Management Companies (AMCs). Sometimes different AMCs choose the same stocks to be part of their fund composition as per the fund’s objective.
Mutual fund overlap happens when an investor has multiple funds that invest in similar securities. This overlap reduces the diversification that was intended before investing and asks fundamental questions about the mutual fund portfolio composition and how it works.
Overlap happens when two different funds try to capture market opportunities by selecting similar stocks to beat their benchmarks. Even if the strategies are other, identical fund objectives can lead to similar fund composition.
For example, if you invest in Fund A, which has shares of XYZ Company and then you invest in Fund B, which also has shares of XYZ, you are experiencing overlap.
A mutual fund portfolio is your collection of various schemes, all aligned with your investment goals and objectives. It gives you an overview of your mutual fund investments and helps you to manage and analyse your portfolio.
You may notice that your portfolio has overlapping investments. You may be diversifying, but overlapping can happen if you invest in similar assets. Lack of diversification can reduce the effectiveness.
Mutual funds are famous for diversification; they offer exposure to a wide range of securities through a single product. However, overlapping investments can negate the benefits of diversification. If the overlapping stocks perform poorly, the funds heavily exposed to those stocks will also perform poorly and compound your losses.
Diversification is essential to reduce risk but must be managed to avoid overlap. Proper diversification can reduce market volatility and leverage on different fund managers. To avoid too much overlap, compare the fund composition before adding it to your portfolio.
Minor overlap doesn’t affect returns much. However, significant overlap can expose your portfolio to company-specific risks and limit returns if those stocks perform poorly. Diversification is to spread risk, and too much overlap can defeat the purpose.
Portfolio overlap is an often overlooked problem, but it can compromise the very purpose of diversification. Diversification can get compromised when multiple mutual funds in a portfolio own similar securities. This can lead to unintended risk concentration. Some overlap is inevitable, but too much overlap can reduce the portfolio’s ability to absorb market volatility significantly if the securities overlap poorly.
Regular portfolio reviews are essential to manage your investments effectively and reduce the impact of mutual fund portfolio overlap. Avoid or eliminate mutual funds with similar strategies or holdings. Diversify your portfolio across asset classes, sectors and fund managers to maximise your risk-adjusted return. You can achieve financial success by having a balanced portfolio and aligning your investments with your financial goals.
Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence.