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A mutual fund (MF) is formed when the capital collected by various investors (can be individual or institutional) is invested in purchasing capital assets such as stocks, bonds, and bills. You can design your mutual fund portfolio by investing in funds that suit your goals and objectives. Mutual funds are broadly classified into debt, hybrid and equity funds, depending on the equity exposure. If the fund you are investing is debt-dominated, then it is termed as a debt fund, if not, then it termed as an equity fund. Hybrid or balanced funds have equal exposures to debt and equity.
Mutual fund portfolio overlap occurs when you invest in two or more different funds investing in the same asset such as shares of a company. You invest in various funds to diversify your investment portfolio. If the funds you invested in purchase the same assets, then your objective of diversifying the portfolio will not be served.
Consider the following example to understand better the scenario of mutual fund portfolio overlap: You invest in ABC MF, which predominantly invests in purchasing shares of the company XYZ. You invest in another MF DEF which also invests in the shares of the same company XYZ. Since both MFs ABC and DEF invest mostly in the shares of XYZ, they are said to be overlapping.
As a mutual fund investor, you don’t get your mutual fund portfolio diversified by merely investing in various funds. A true diversification of the portfolio happens only when the funds you invest, in turn, invests across multiple asset classes. If the asset class in which your funds have invested suffer losses, then the overall loss of the portfolio would be magnified if there is an overlap.
To avoid mutual fund portfolio overlap, you need to check the asset classes in which the funds invest. Various websites help you with finding out if the funds are overlapping. You need to enter the scheme names, and they show if the funds are overlapping.
Diversification of the portfolio helps to maximise the returns on the investment. Investing in different asset classes facilitates risk mitigation. Although diversification does not guarantee the prevention of losses, it does help in minimising the losses. Portfolio diversification is essential for long-term investments. Better diversification of the portfolio helps in downside protection, and market volatility will be under control. Diversification of the portfolio will make sure that if one asset class performs below the expectations, then your overall portfolio is not impacted in a big way. It is always wise to know the investment goals of the funds before investing. It is good to consider investing across various funds. Avoid overlapping as it amplifies the losses.