4 Important Tips To Avoid Portfolio Overlap While Investing In Mutual Funds

By BankBazaar | January 31, 2018

Buying the same kind of funds would mean buying the same kind of stocks or even same stocks. This will lead to concentration risk. Here’s how to have a well-balanced portfolio.

4 Important Tips To Avoid Portfolio Overlap While Investing In Mutual Funds

Portfolio overlap could be a lot like you and your family ordering the same kind of food at a Japanese restaurant. How? Let’s assume none of you know Japanese (that may be more of a truth than an assumption) and translations are not available on the menu. Maybe you want Oshitashi, but Gomaae sounds good too.

So, you order Oshitashi and your sibling orders Gomaae. You are delighted as you can taste both dishes. When the dishes arrive you find out both are boiled spinach! Wish you had asked the waiter, right?

Similarly, Mutual Funds might have different names, but they could invest in the same stocks. That means you, as an investor, are investing in the same stocks. This is called portfolio overlap where few funds have the same underlying stocks. There’s nothing wrong with a portfolio overlap like this. However, if you have invested in very few funds, this could be very risky.

You need to know how much company-specific risk or sector-specific risk is there in your portfolio. After all, you don’t want your portfolio to be overly dependent on a few stocks, right? Portfolio overlap defeats the whole objective of diversification. What’s the use of diversifying your portfolio when you still have to bear the risks that were there before you diversified? So, here are a few things you should keep in mind to avoid any overlaps.

Do not buy too many funds run by the same fund manager

Mr.X is a good fund manager and his funds give great returns. Is it profitable to invest all your money only in his funds? Not really!

Just like you have your own way of going about your work, fund managers have theirs. Each manager has a style that he/she follows irrespective of the fund they run. If he is bullish on a particular stock or sector, he might ensure that that stock or sector is a part of all the funds he/she manages.

So, you could be taking on more stock-specific/sector-specific risk because the percentage of that stock/sector will go up in your portfolio. Imagine investing half of your money in the automobile or banking sector alone? You could miss the bull-run in other sectors such as FMCG.

Also, as far as your portfolio is concentrated, when that stock/sector goes down, your entire return will get hit. So, even if you are totally in love with your fund manager, do not buy more than two of his/her diversified funds.

 

Do not keep buying funds from the same fund house

Every household has a value or culture that’s unique to it. Similarly, every fund house has a unique culture that is followed by all its fund managers.

For example, Sundaram Mutual Fund is regarded as a very conservative fund house and fund managers might adopt the conservative approach for their funds. Another risk is that the fund managers of a particular fund house may invest in the same stocks or sectors.

So, do not buy a number of Mutual Funds from the same fund house. Invest across fund houses so that your portfolio is a well-rounded one.

Watch the sector weightings

Sometimes funds from different Mutual Fund houses tend to invest in the same sector. It is quite possible that many funds are bullish on the same sector at the same time. Maybe because that sector is sought after.

Banking and finance is a good example. In the last year, more than 100 funds had major investments in this sector. Unbelievable? Maybe. But it’s true.

Several banking and financial companies have given great returns in the past few years, but due to Non-Performing Assets (NPA), the banking sector took a hit a few years ago. What would have happened to your returns if you had invested majorly in this sector? Obviously, they would have gone down.

So, keep monitoring the sector weightings of your funds. This will help ensure that you have invested across sectors.

Additional Reading: Is It Safe For Retirees To Put Their Money In Mutual Funds?

Check whether there are too many large-cap funds in your portfolio

Can you guess how many funds hold shares of Reliance Industries? 50? No! 100?? Wrong! The answer is over 200 funds!

Large-cap companies form only a small part of the market. What does that mean? Simple! There aren’t many large-cap companies. The number of mid-cap companies and small-cap companies are far more in number. So, large-cap funds tend to invest in the same set of large-cap stocks.

Infosys and Reliance Industries are two stocks that are a testimony to this fact. If you invest in too many large-cap funds, there is a pretty good chance that you are investing in the same set of companies. This will, of course, lead to company-specific risk. So, avoid buying too many large-cap funds.

Diversifying across Mutual Funds is as important as diversifying across asset classes. Keep this in mind when investing in Mutual Funds.

Looking for other financial products to invest in. You’ve come to the right place.

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Category: Money Management Mutual Funds

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