Mutual Fund Overlap: What It Means and Why It Matters

When Your Mutual Funds Start Looking Like Twins

You walk into a sweet shop and buy five different boxes of mithai, thinking you’re getting variety. But when you open them at home, you discover they all contain the same gulab jamuns and rasgullas. That’s exactly what happens when your mutual fund portfolio suffers from overlap you think you’re diversifying, but you’re actually putting your eggs in very similar baskets.

Mutual fund overlap occurs when multiple schemes in your portfolio hold the same stocks. Think of it as accidentally ordering the same dish from different restaurants  you’re paying more but getting essentially the same meal.

Understanding the Mechanics of Overlap

Fund overlap happens because fund managers often gravitate towards the same high quality stocks. When you own a large-cap fund, a multi-cap fund, and a flexi-cap fund, chances are they’ll all hold shares of Reliance Industries, HDFC Bank, and Infosys. This isn’t surprising  these are solid companies that most fund managers want in their portfolios.

The overlap gets measured as a percentage. If two funds hold identical stocks worth 60% of their total assets, they have a 60% overlap. Anything above 70% is considered high overlap, while below 30% is relatively low.

Why Overlap Creeps Into Your Portfolio

Several factors contribute to this phenomenon:

1. Similar investment mandates: Large-cap funds, by definition, must invest in the top 100 companies by market capitalisation. When multiple funds follow this mandate, overlap becomes inevitable.
2. Fund manager preferences: Most managers prefer blue-chip stocks because they’re stable and liquid. This natural selection process leads to similar holdings across different schemes.
3. Market concentration: The Indian equity market is top heavy, with the largest 50 stocks accounting for a significant portion of total market capitalisation. Fund managers often have limited choices when building diversified portfolios.
4. Benchmark tracking: Many funds closely track popular indices like the Nifty 50 or Sensex, automatically creating overlap with other benchmark hugging funds.

The Hidden Risks of Overlap

Overlap might seem harmless, but it carries several risks that can hurt your wealth creation goals:

Concentration risk amplifies significantly. When multiple funds hold the same stocks, you’re essentially making oversized bets on specific companies without realising it. If HDFC Bank faces troubles, all your funds holding this stock will suffer simultaneously.

Diversification becomes an illusion. You might think you’re spreading risk across different funds, but high overlap means you’re exposed to the same market movements. Your portfolio becomes less resilient to sector-specific or stock-specific shocks.

Cost efficiency takes a hit. You’re paying management fees to multiple fund houses for essentially similar stock selection. This increases your overall expense ratio without proportional benefits.

Performance correlation increases. When funds hold similar stocks, they tend to move in the same direction. During market downturns, all your funds might decline together, defeating the purpose of diversification.

Identifying Overlap in Your Portfolio

Several tools can help you detect overlap:

Most mutual fund platforms now offer portfolio overlap analysis. You can input your fund holdings and get a detailed breakdown of common stocks and their weightages.

The Association of Mutual Funds in India (AMFI) website provides monthly portfolio disclosures for all schemes. You can manually compare holdings, though this method is time consuming.

Financial advisors often use professional software that instantly calculates overlap percentages across multiple funds.

Smart Strategies to Reduce Overlap

1. Choose funds from different categories: Instead of buying three large-cap funds, consider one large-cap, one mid-cap, and one small-cap fund. This naturally reduces overlap while providing genuine diversification.
2. Select funds with different investment styles: Combine growth funds with value funds, or blend active funds with passive index funds. Different styles often lead to different stock selections.
3. Consider sectoral or thematic funds carefully: While these can reduce overlap with diversified funds, they introduce concentration risk of their own. Use them sparingly and strategically.
4. Review and rebalance regularly: Portfolio overlap changes as fund managers buy and sell stocks. What looked diversified six months ago might show high overlap today.
5. Focus on fund house diversity: Different asset management companies often have varying investment philosophies, reducing the likelihood of identical stock picks.

When Some Overlap Might Be Acceptable

Not all overlap is bad. A moderate overlap of 30-50% between funds can be acceptable if:

The overlapping stocks are fundamentally strong companies that form the backbone of the Indian economy. Some exposure to quality stocks across funds isn’t necessarily problematic.

You’re investing for different goals with different time horizons. The same stock might serve as a growth driver in one fund and provide stability in another.

The funds have different risk profiles despite some common holdings. A large-cap fund and a multi-cap fund might both hold the same blue chip stocks but with different weightages and additional holdings.

Practical Implementation Steps

Start by listing all your mutual fund holdings with their portfolio dates. Most funds update their portfolios monthly, so use the latest available data.

Use online overlap analysis tools or spreadsheets to identify common stocks and their combined weightages in your portfolio. Focus on stocks that represent more than 5% of your total equity allocation.

If overlap exceeds 70% between any two funds, consider replacing one with a fund from a different category or investment style.

Monitor your portfolio quarterly for changing overlap patterns, as fund managers regularly adjust their holdings based on market conditions and opportunities.

To sum up:

Mutual fund overlap is like having multiple keys to the same lock it might feel safer, but it doesn’t actually provide additional security. While some overlap is natural and acceptable in a diversified portfolio, excessive overlap defeats the purpose of owning multiple funds and can amplify risks instead of reducing them.