How overlapping mutual funds reduce your returns and what to do about it

Representative image

Mutual fund overlap occurs when two or more funds in your portfolio invest in the same or similar underlying stocks or sectors. While many investors believe that owning multiple mutual funds ensures diversification, overlapping funds can lead to an over-concentration in specific companies or industries, reducing the actual diversification benefit. This can increase risk and lead to portfolio inefficiencies, especially during market downturns when correlated assets fall together.

For example, two large-cap equity funds may both hold top stocks like Reliance Industries, HDFC Bank, or Infosys. Owning both funds doesn’t double your exposure—it concentrates it.

How to identify overlapping funds in your portfolio

To spot fund overlap, you can start by checking the top 10 holdings of each mutual fund in your portfolio. Many investment platforms, such as Value Research, Morningstar, or Groww, offer tools that analyse overlapping stocks between funds. A significant overlap—typically above 50%—suggests that the funds may be investing in similar themes or stocks.

Additionally, reviewing fund categories helps. Holding three funds from the same category, such as large-cap or flexi-cap, often results in redundancy.

The impact of overlapping funds on performance

While diversification aims to spread risk, overlapping funds can create hidden concentration risks. If several of your funds are overweight on the same stocks, any decline in those companies will disproportionately impact your portfolio. Moreover, this redundancy doesn’t significantly enhance returns but can increase volatility and lead to confusion when tracking performance.

In the long run, it may also inflate costs if you’re paying multiple expense ratios for funds delivering similar outcomes.

What you should do to fix overlapping investments

1. Consolidate your holdings: Retain the best-performing and most consistent fund in each category and exit others with high overlap or underperformance. This not only simplifies your portfolio but also reduces tracking effort.

2. Diversify across categories: Include funds with distinct mandates such as mid-cap, small-cap, international equity, debt, or sector-specific funds to spread risk and tap into different growth opportunities.

3. Review periodically: Fund compositions change over time, so conduct an overlap analysis at least once a year to ensure your portfolio remains balanced.

4. Use direct plans: While trimming overlap, switch to direct mutual fund plans if you haven’t already. These come with lower expense ratios, which helps improve long-term returns.

5. Seek professional advice: If unsure, consult a SEBI-registered investment advisor to help rationalize your fund selection based on your goals and risk tolerance.

The ideal number of mutual funds to hold Most financial planners recommend holding 4–6 well-chosen mutual funds spread across different categories. More than that often leads to duplication and inefficiency. A lean, well-diversified portfolio with minimal overlap is easier to monitor, more cost-effective, and aligned with long-term wealth creation goals.