Mutual funds are known solely for the well-diversification of their investment portfolio, but what happens if your fund manager has invested in a very similar manner in different mutual fund schemes? Before jumping into what is the overlap of mutual fund portfolios, let’s dive deep into the basic concepts.
How does a mutual fund company diversify your portfolio?
Diversification can be done in various ways, it could be a mix of stocks with 50 percent and debt with 50 percent and the ratio of different asset classes varies according to your risk appetite. Assets classes could be debt, gold, stocks, and commodities.
However, to narrow down the concept of diversification and serve the best as per your financial requirements, mutual fund managers came up with different sub-categories of funds as well as per your risk tolerance level.
For example, if you are willing to invest in stocks, but still want to play relatively safe, you may invest in large-cap mutual funds. On the other hand, if your risk appetite is aggressive and looking forward to getting better returns in the coming future, you may prefer to invest in mid-cap funds.
How do you diversify your portfolio through mutual funds?
You may also have different strategies to diversify your portfolio through investing in different types of mutual funds. For example, to gain the best returns on investments with the given risk appetite, you have invested in different mutual funds as follows-
- 50 percent of your total investment in ABC funds
- 30 percent of total investment in XYZ funds
- Remaining invested in PQR
By investing in different mutual funds, you get exposure to different investment strategies followed by the different mutual fund schemes and optimise your returns by diversifying risks.
When does diversification overlap?
It occurs when two or more mutual funds hold similar securities in their portfolios. This can happen because different fund managers have similar investment strategies or because certain securities are popular among investors.
For example, suppose an investor holds two mutual funds - Fund A and Fund B - that both have significant holdings in large-cap Indian stocks such as HDFC Bank, Reliance Industries, and Infosys. In this case, there is a high degree of portfolio overlap between the two funds, as they hold similar securities.
While portfolio overlap can provide diversification benefits, it can also increase concentration risk. If a significant price drop occurs in one of the overlapping stocks, both funds may be negatively impacted.
How to minimise the risk of mutual fund portfolio overlap?
There are a few things to steps you can follow to minimise the risk of mutual fund overlapping-
- Review the holdings of multiple mutual funds
- Diversify across different asset classes
- Consider funds with different investment styles
- Use a tool to analyse portfolio overlap
- Consult with a financial advisor
Market volatility and the risk of losing your capital is not only a way to keep your money safe while investing, there are various other things to consider before investing in mutual funds and portfolio overlapping is one of them. However, every risk can be reduced by making informed financial decisions.
Anushka Trivedi is a freelance financial content writer. She can be reached at anushkatrivedi.com
Disclaimer: This story is for informational purposes only. Please speak to a SEBI-registered investment advisor before making any investment-related decision.
