If you invest in multiple mutual fund schemes, chances are that some of these funds will have overlapping stocks. A few overlapping stocks shouldn’t really worry investors, but their valuations can ring alarm bells when they comprise the majority of your portfolio.
So it is important to first identify the extent to which these funds have overlapping stocks and then act on it i.e. sell one or more funds to ensure healthy diversification in your portfolio.
And why not? After all, diversification in your portfolio can seriously hurt your returns.
“Having common stocks is fine, but when they’re a fraction of your portfolio, what happens… When these stocks fall — your entire portfolio falls. There are two situations that can arise in this. First, you wait and see if the overlap is small, and second is to sell some of your investments to reduce the overlap,” Prime Investor founder Vidya Bala shared in a video on the video streaming platform.
She explains that by accumulating too much, investors not only bear a significant financial risk, but also lose out on other stocks that could be great investment opportunities when the stocks in your portfolio are declining.
How to identify
Identifying fund overlaps is very easy using PrimeInvestor’s online tool. One can write the names of two mutual fund schemes and get the overlap of two fund schemes.
For example, HDFC Flexi Cap Fund and HDFC Top 100 Fund show an overlap of 62 percent. As one scrolls down, one can find out the allocation to mutual stocks of these funds, in this case Axis Bank, Airtel, BPCL and Ciplan.
One should see that 60 percent overlap is common in large-cap or large-cap-oriented stocks. But anything outside of that is a lot, like 70 percent. It means you don’t need to keep both funds in the portfolio.
This is how the online overlap tool shows the mutual stocks between two or more mutual fund schemes.
Sometimes two funds in the same category carry a low overlap ratio in different AMCs. For example, Parag Parikh Flexi Cap and HDFC Flexi Cap have only 21.6 percent overlap.
How to fix it
Once two or more mutual funds are determined to have a significant share of common stocks, one can decide which mutual funds to hold and which to sell. Although this may seem like a tough decision to make, it may take a call between the current valuation and other performance indicators such as leverage ratio, standard deviation, outperforming the benchmark and other indicators.
It is important to note that mutual fund houses tend to change their portfolios – so the overlap between different schemes may change.
So, the next time you want to invest in a new mutual fund, try to remember the old adage: don’t put all your eggs in one basket.
Here we share the benefits of portfolio diversification.
First published: December 20, 2022, 02:45 pm IST