When investors do not diversify mutual fund investment portfolio and invest in two or more funds with the same objective, fund overlapping occurs. In this article, let’s get to know more about mutual fund portfolio overlap.
When a person invests in different investment schemes which have the same holdings, there is a fund overlap. Mutual fund overlap happens when an investment is in various schemes with the same holdings. It is not suitable for diversification. If the allocation of investment is not diversified, then the investments have a high risk. In such situations, there is no drop in risk factor as the investments have the same holdings.
If the value of one scheme falls, then the value of other schemes also fall as they have the same holdings. Many people fail to understand that investing in different schemes is not diversification. A portfolio is diversified when a person invests in different funds, sectors, etc.
A mutual fund portfolio means investing in different instruments such as stocks, shares, bonds, etc. It comprises of equity, debt, and balanced funds. It is a debt fund if a portfolio has more debt instruments. If a person has more investment in equity instruments, then it is an equity fund. However, when the investment is made in equity as well as debt, then it is classified as a balanced/hybrid mutual fund.
Mutual fund overlap when a person invests in different funds, but the investments are made in the same holdings of a company. In such situations, there is no diversification. There must be no fund overlap as it can increase risk. Also, it can cause losses, even if the value of one fund falls. If a person has invested in the same holdings, then such a portfolio isn’t diversified.
For example, a person invests in two different mutual funds. If the mutual funds invest in the same company, then there is an overlap in the portfolio. The investor will lose money if the price of the funds falls as their portfolios are the same.
It is difficult for many investors to understand diversification. Investing in different funds doesn’t have to be diversification. A person must have a diversified investment portfolio to reduce the risk as there will be no overlap.
One of the ways a person can find if there is a fund overlap is by understanding the sectors of investment. Many websites help an investor know if their funds are overlapping. The investor needs to provide their schemes to find overlapping funds on such websites. A person can find the common and uncommon stocks in a portfolio. Also, the percentage and quality of overlapping funds.
To reduce overlapping funds, an investor needs to know the different types of mutual funds such as-
Equity funds have a high risk. However, they can also offer higher returns. There are different types of equity funds, such as small-cap, mid-cap, multi-cap, and large-cap funds.
Debt funds are investments made in securities such as money market instruments, corporate bonds, etc. The risk of debt funds is low. However, their returns can also be low compared to equity funds.
In such funds, investments are made in equity as well as debt funds. While the risk with equity funds is high, balanced funds can offer lower risk by allocating investment in debt as well.
Diversification is important to reduce the risk of an investment portfolio. However, when funds overlap, the risk gets high as the investor can face loss even if the Net Asset Value of (NAV) of a mutual fund unit fall.
Mutual fund diversification impacts a portfolio a lot as it can help an investor earn higher returns. However, it is important to have a portfolio diversified for the long-term.
It is difficult to understand when a market will dip or rise. If a person has invested in only one sector and its price falls, then they can lose their money. In such situations, diversification helps as a person doesn’t have to face a lot of risk from one sector.
Diversification in different sectors, funds, etc. helps investors against mutual fund portfolio overlap. It also impacts the returns of an investor. However, to earn higher returns, a person needs to be invested for a longer-term.