Mutual Funds: A Brief Note on Portfolio Overlap

An equity mutual fund scheme invests in a portfolio of stocks as per the guidelines of the Securities and Exchange Board of India (SEBI). 

In this regard, a large-cap fund will invest about 80% of its stocks ranked 1-100 by market capitalisation (m-cap). Similarly, a mid-cap is mandated to put about 65% in stocks ranked 101-250 by m-cap. 

There is a possibility that investors may park money in two to three large-cap funds of various Asset Management Companies (AMCs) or fund houses to promote diversification of the portfolio. 

However, chances are high that a significant portion of the money would be invested in a similar set of underlying stocks. For instance, there is a possibility that all the funds would hold the same large banks, Information Technology (IT) companies, and various conglomerates. Such a situation is referred to as portfolio overlap in mutual funds. 

Among the reasons for such a scenario of portfolio overlap is the market regulator guidelines, which specify where a particular category of mutual fund scheme (large-cap, mid-cap, small-cap, and multi-cap funds) could invest. 

Considering that this universe is limited, there are chances of overlaps among various schemes. Also, in case an investor has invested in funds from the same fund house, there is a possibility of overlap, as per wealth managers. 

There is a specific style, method, and philosophy of building a portfolio by AMCs, and there is a possibility that the stocks that they buy in a large-cap fund are likely to overlap with those in the flexi-cap, multi-cap, value, or focussed schemes of the investment portfolio. 

Although it may not be possible to eliminate portfolio overlaps completely, the idea is to try to keep them as low as possible in order to gain from diversification. 

An investor can try to diversify investments across fund categories as one of the strategies to avoid portfolio overlaps. For instance, an investor can allocate 60% of the corpus to a large-cap fund, 20% to mid-cap and small-cap funds, and 10% to thematic or sectoral funds. 

In addition, one can avoid overlap due to the investment style of an AMC by investing in funds from different fund houses, which will also aid in the diversification of the portfolio.

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