Multiple mutual funds, same stocks? Here’s how to check for portfolio overlap

If you own three or four mutual funds, you may feel that your portfolio is well-diversified. However, a closer look at their portfolios may reveal that they hold many of the same top 10 stocks in similar proportions. This is known as portfolio overlap. While you may think you are spreading your risk across multiple funds, you could actually be concentrating your exposure to the same stocks. Here is how to identify portfolio overlapping, as reported by ETWealth.

Portfolio overlap refers to the extent to which two or more mutual funds hold the same stocks. The higher the overlap, the lower the actual diversification in your portfolio.

Overlap happens because many funds fish in the same pond. Indian large-cap funds, for instance, are all benchmarked to the Nifty 50 or similar indices. The universe of liquid, investable large-cap stocks is not that large. Fund managers running different funds end up with similar convictions on the same dominant companies.

The simplest way to measure overlap between two distinct mutual funds is to list the stocks in each, assign portfolio weights, and calculate what percentage of holdings are common. A 30-35% overlap is fairly common. Above 50% starts to be a concern. Above 70%, the two funds are essentially mirror images of each other and holding both adds little value.

Overlap becomes a real cause of concern when the common stocks go through a rough patch. If four of your mutual funds all own that one stock that falls 30%, that loss hits your portfolio four times—once through each mutual fund. You feel the damage much more than you would have if your funds had genuinely different holdings

The portfolio overlapping also means that you are paying multiple sets of expense ratios for exposure you could have got from a single fund.

Before adding a new fund, check its top 10-15 holdings against what you already own. If the new fund’s top holdings look identical to your existing ones, it is not adding much. Pay attention when combining funds within the same category

Some overlap is inevitable and not worth losing sleep over. If you hold an index fund and a large-cap active fund, they will share many stocks -- that is expected. What matters is whether the funds together achieve different objectives.