How to deal with portfolio overlap

By Ravi Samalad |  05-04-22 | 

The mutual fund industry offers more than 1,400 schemes across different categories and choosing the right fund which will add provide optimal diversification can be a herculean task for any investor.

For instance, there are 32 funds within the Large Cap category. If one keeps adding funds within the same category, there are chances that the investor might end up owning the same stocks across different funds. So how does one go about selecting the right fund to avoid portfolio overlap? We asked few advisers about what investors should keep in mind to avoid concentration risk.

Dev Ashish of Stable Investor says that even if there is some amount of overlap in your portfolio, it could bode well for your portfolio but a higher overlap is not desirable. “If there are good stocks in a fund’s portfolio, then chances are that particular ‘good’ stock will also feature in another fund (unless restricted by fund category mandates). But if the overlap between funds is extreme, say like 60-70%, then that exposes the overall portfolio to the concentration risk (across companies and sectors). This risk may work in favor or against the investor depending on how the concentrated part of the overlapped portfolio does in the market.”

Each fund should serve an objective

Dev says that each fund should have an objective in your portfolio. “When building a mutual fund portfolio from scratch or cleaning up an existing portfolio, the idea should be to have a minimalist portfolio without having too much concentration. This can be achieved by having each fund serve a specific purpose in the portfolio. The purpose can be to have exposure to a specific market segment (like Large Cap funds, Mid-Cap funds, Small Cap funds) or investment style (go anywhere funds like Flexi Cap, Focused Funds, Value Funds, etc.). And if such a portfolio has funds that still overlap, then that shouldn’t be too much of a worry for the investor. Anyways, portfolio overlap isn’t static and changes often.”

How many funds within one category?

Rushabh Desai, Founder - Rupee With Rushabh Investment Services, says that the number of funds an investor should have under one category will depend on the investor's portfolio construct and risk appetite. “If the investor's portfolio is well diversified then ideally one fund within the category is enough and will do the job. But if the investor's portfolio is not well diversified and is only investing in one particular category example the "Flexi Cap Category" then two to four funds can be looked at. This is only if the investor is invested in one single category.”

Dev suggests that keep the number of funds in each category to a minimum. “Once the funds have been picked for a specific purpose in the portfolio, the overlap should not be given too much weightage and one should rely on the fund manager’s capability to build the right portfolio of stocks. I think that for a smaller portfolio, having 1 fund from each category (not all but suitable ones only) is enough. For larger portfolios, having 1-2 funds (or a max of 3 funds) from any category is fine in spite of a bit of overlap.”

High concentration can backfire

Kaustubh Belapurkar, Director – Manager Research, Morningstar Investment Advisers India, says that investors should do some due diligence while adding a new fund to their portfolio. “Investors tend to add funds in their portfolio without checking the similarity of the holdings of the fund with their existing fund(s). If the fund has a high common holding score with the existing portfolio, adding that fund doesn’t offer substantial diversification benefits. This amounts to adding more of the same, resulting in the portfolio being skewed towards a particular style or capitalization bucket. This can result in polarized returns during varied market cycles. Adding funds with low common holdings score helps in building a truly diversified evergreen portfolio.”

Let us look at a few examples of two Large Cap Funds which follow a growth investing style. According to data from Morningstar Direct, Axis Bluechip and Canara Robeco Bluechip have a common holding score of 59% as of February 2022.

These were the top 20 common stocks held by both funds as of February 2022.


If we compare Axis Bluechip (Growth style) with HDFC Top 100, which follows a Blend investment style (mix of growth and value) style the common holdings score is 41%.


Don’t chase recent performers

A classic case for example is when investors chase funds that have delivered good returns. “In 2019/20 investors largely invested in pure Growth style funds, since the recent historical returns of these funds were superior. This resulted in investor portfolios being heavily tilted towards only high Growth stocks. Come 2021, when value has performed relatively better, these portfolios have underperformed during this period. It is impossible to time the market cycles, so it is prudent to identify consistently run strategies with different investment mandates (witnessed through portfolio similarity scores) and invest in a mix of these,” adds Kaustubh.

Diversify across fund managers, style, and fund house

Rushabh says that investors should focus on selecting funds of different styles, strategies, fund managers, and fund houses and not concentrate on the underlying stocks the funds possess. “Even if funds have a certain number of stocks overlapping one need not worry as long as the fund's style, strategy, stock and sectoral allocation are different. Based on the fund manager's foresight stocks keep on changing so if there are certain common stocks today this might not be the same after a few days or months. I would recommend investors to pay more attention and select funds of different styles, strategies, fund managers, and fund houses.”

To sum up, investors would do well to not only diversify across categories but also across investment styles.

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