The reason many investors invest in mutual funds is to diversify their holdings. As investors invest in multiple stocks, they diversify from concentration risk where if one stock goes down for any reason their whole portfolio goes down.

What Is Mutual Fund Overlap?

When investing in multiple mutual funds, some of the funds would have invested in the same set of stocks. This is normally termed as mutual fund overlap. So when an investor puts money in multiple funds but invests in the same set of stocks that causes an overlap.

While sometimes mutual fund overlap is unavoidable as multiple funds invest in the same stocks because they are good. So it might be impossible to completely avoid mutual fund overlap.

What Are The Disadvantages Of This?

The main issue of this phenomenon is reduced diversification. When investors think they have invested in multiple mutual funds and hence they are diversified, but if the funds invest in same set of stocks, then it increases concentration risk for the portfolio as one or two stock could sink a portfolio. The investors also face risk of lower returns if the same set of stocks underperform for a long time. They would be losing money in terms of expense ratio for the same set of stocks.

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How To Avoid Mutual Fund Overlap?

While completely avoiding mutual fund overlap is impossible, there are ways through which investors can reduce mutual fund overlap. Investors could invest in funds across different market capitalisations to reduce concentration.

Large Cap Funds invest 80% of their funds in Nifty 100 stocks while Midcap funds invest mainly from the next 150 companies in market cap and the small cap funds have a much larger universe of coverage. Hence investing in one fund from each market category should be sufficient for an investor to reduce overlap risks.

Investing among different asset classes and fund types such as hybrid funds, money market funds and gold and silver funds can also help investors to reduce their risks and achieve diversification. 

Another thing that investors can do is invest in funds from different Asset Management Companies (AMC). Different AMCs have different styles of investments and put money in different stocks by spreading out investments in multiple funds, the investor can reduce the concentration risk. 

Investors should also remember to monitor their portfolio and funds to see how much overlap there is.

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