When building a diversified investment portfolio, many investors turn to mutual funds for their simplicity and broad exposure to different markets. However, a common oversight is not checking for mutual fund overlap. Overlap occurs when multiple funds in a portfolio hold the same underlying stocks or assets, reducing diversification and potentially increasing risk. Comparing mutual funds for overlap is essential to ensure that your investments are truly diversified, especially if you are allocating funds across multiple asset classes or sectors. Ignoring this factor can result in over-concentration and unwanted volatility in your portfolio.
What Is Mutual Fund Overlap?
Mutual fund overlap refers to the presence of the same securities in multiple funds. For example, if two of your mutual funds both hold large positions in Apple, Microsoft, and Amazon, you are indirectly overexposed to those companies. Even if these funds are categorized differently such as a technology sector fund and a large-cap growth fund the holdings might substantially intersect.
Types of Overlap
- Stock Overlap: Common individual stocks across multiple mutual funds.
- Sector Overlap: Funds heavily weighted in the same sectors, such as healthcare or technology.
- Geographical Overlap: Funds investing in the same region or country.
- Style Overlap: Multiple funds investing in growth, value, or dividend-paying stocks.
Why Overlap Matters
While some overlap is inevitable, excessive duplication can dilute the benefits of diversification. The primary purpose of owning different mutual funds is to spread out your investment risk. However, when the underlying holdings are too similar, you may not be as protected against market swings as you think.
Key Risks of Overlap
- Reduced Diversification: Overlap undermines the goal of spreading risk across different companies and sectors.
- Overexposure to Specific Stocks: A downturn in a highly weighted stock can disproportionately impact your portfolio.
- Increased Volatility: Similar funds may react similarly to market events, amplifying losses.
- Missed Opportunities: Duplication means you might be missing exposure to other valuable sectors or markets.
How to Compare Mutual Fund Overlap
1. Review Fund Holdings
The first step is to look at the top 10 or top 25 holdings of each mutual fund in your portfolio. These details are usually available on the fund’s official website or in the fact sheet. Identify which stocks appear in multiple funds.
2. Use Overlap Analysis Tools
Several investment platforms and research tools offer mutual fund overlap analysis. These tools allow you to compare two or more mutual funds side-by-side, showing the percentage of overlapping holdings by value or quantity. Look for:
- Percentage Overlap: What proportion of a fund’s assets are shared with another.
- Weight Overlap: The combined weight of duplicated holdings in your portfolio.
- Concentration Risk: How much exposure you have to a specific stock or sector.
3. Assess Correlation and Beta
Another way to understand overlap is by reviewing statistical measures like correlation and beta. If two funds have a high correlation, they are likely to move similarly in market conditions suggesting overlap. Beta also shows how sensitive a fund is to market movements.
4. Evaluate Fund Objectives and Strategies
Even funds with different names or categories might have similar investment objectives. Read through the fund’s investment strategy section to see if they target the same companies, sectors, or growth profiles.
Examples of Overlapping Funds
Let’s consider two hypothetical mutual funds:
- Fund A: A large-cap growth fund with top holdings in Apple, Amazon, Google, Microsoft.
- Fund B: A technology sector fund with top holdings in Apple, Microsoft, Nvidia, Meta.
Even though one focuses on a broad category (large-cap growth) and the other is sector-specific (technology), they overlap significantly in their top holdings. Owning both might expose you to undue concentration in tech giants.
How Much Overlap Is Acceptable?
There is no exact percentage that defines too much overlap, but as a rule of thumb:
- Under 10% Overlap: Usually acceptable; offers reasonable diversification.
- 10%25% Overlap: Moderate; requires further evaluation based on overall portfolio goals.
- Over 25% Overlap: High; may suggest redundancy and risk of overexposure.
Strategies to Minimize Mutual Fund Overlap
1. Diversify by Fund Manager and Style
Choose mutual funds managed by different fund houses with distinct investment styles. One manager might favor value investing, while another prefers growth strategies. This variation helps reduce overlap.
2. Select Thematic or Regional Funds Carefully
If you include thematic funds (e.g., energy, ESG, AI) or international funds, check how much they overlap with your core holdings. Regional diversification can also help avoid duplication with U.S.-centric funds.
3. Combine Active and Passive Funds
Passive index funds often have high overlap with other index funds. Combining them with actively managed funds that take different positions can reduce duplication.
4. Rebalance and Monitor Periodically
Even if your funds were distinct when purchased, changes in market cap or fund strategies can increase overlap over time. Periodic portfolio reviews help maintain healthy diversification.
Benefits of Reducing Overlap
Once you identify and reduce unnecessary overlap in your mutual funds, your portfolio benefits in several ways:
- Improved diversification and reduced concentration risk
- More stable returns across different market cycles
- Greater exposure to a variety of industries and investment styles
- More effective use of capital across asset classes
Comparing mutual funds for overlap is a critical but often overlooked step in smart portfolio management. Without proper analysis, you might end up investing in multiple funds that offer similar exposure, limiting the benefits of diversification and increasing your risk. Tools and strategies to identify mutual fund overlap can help you build a more balanced and efficient investment portfolio. Whether you’re a beginner or a seasoned investor, reviewing mutual fund holdings and overlap should be a routine part of your investment planning process. In the long run, this attention to detail can lead to more consistent performance and better risk-adjusted returns.