Tackling portfolio overlap: Invest fresh money in underrepresented segments

When building a portfolio, diversify by market cap, style, and geography to minimise chances of overlap

The Securities and Exchange Board of India (Sebi) plans to tighten scrutiny when a fund house launches a new sectoral or thematic scheme. It will seek a model portfolio and examine whether the proposed fund overlaps by more than 50 per cent with an existing scheme from the same fund house. While this addresses overlap at the scheme and fund-house level, investors must scrutinise their own portfolios for overlaps.

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Portfolio overlap refers to the same stocks appearing across fund portfolios. “Such overlapping funds move in tandem, reducing the diversification benefit of holding multiple schemes,” says Kaustubh Belapurkar, director – manager research, Morningstar Investment Research India.

Why it happens

Overlap typically arises when investors add too many funds indiscriminately based on past returns, especially if they belong to the same category. Buying multiple schemes from the same fund manager (say flexicap and ELSS fund) can result in overlap. Investing in too many sectoral and thematic funds that have a limited universe of stocks to invest in, and often hold stocks that are already present in diversified funds, can also increase the chances of overlap.

 

“New fund offers also contribute, as portfolios are not disclosed at launch, leaving investors unable to assess common holdings,” says Vishal Dhawan, founder and chief executive officer, Plan Ahead Wealth Advisors.

How to check for portfolio overlap

A basic check begins by comparing the holdings of two funds. Download their portfolios in Excel and identify the common stocks (at least the top 10). “Investors should examine not just the names, but also the weightages. A stock that accounts for 10 per cent weight in one fund and 1 per cent in another causes only a minor overlap,” says Dhawan.

Several mutual fund websites have online tools that allow investors to check overlap at the portfolio level, though some require a subscription.

 

To prevent overlap at the portfolio construction stage, investors must consciously diversify by market cap, style, and geography.

Diversification by market cap

Different market cap segments perform differently across cycles. “Large caps tend to offer stability during periods when markets are struggling. Mid- and small-cap stocks can generate higher long-term returns but experience sharper drawdowns during downturns,” says Deepesh Raghaw, a Sebi-registered investment advisor. He adds that diversifying across large, mid and small cap funds can combine the benefits of participation in rallies with downside protection.

 

Allocation to different market caps should reflect the investor’s risk tolerance and investment horizon. Investors who have higher risk tolerance and longer investment horizons can go for higher exposure to mid and small cap funds.

Diversification by style

Investment styles—growth, value, momentum and quality—also go through cycles. “No one can predict which style will outperform at which point in time,” says Belapurkar. Blending various styles in a portfolio can ensure that some part of it performs, irrespective of which style is in favour.  Investors can assess a fund’s style through fund disclosures, style boxes, Sebi’s categorisation, and fund managers’ interviews, where they elaborate on their investment approach.

Diversification by geography

Geographical diversification smoothens portfolio performance as different markets perform in different years. “Domestic and international markets respond to varied drivers such as commodity cycles, technology cycles, interest rates, inflation and geopolitics,” says Dhawan.

 

Belapurkar adds that overseas exposure provides access to businesses that may not be available on the local bourses. Raghaw points out that international diversification offers a hedge against rupee depreciation.  

How to remove overlap

Some overlap is inevitable. “If overlap is excessive, investors may need to exit certain schemes, keeping taxes and exit loads in mind. Alternatively, directing fresh money—through lump sums or systematic investment plans (SIPs)—into underrepresented areas can gradually reduce overlap,” says Dhawan.

 

Portfolio restructuring should begin by deciding on an asset allocation across equity, debt, precious metals and real estate based on risk tolerance and investment horizon. Investors should then decide exposure to sub-asset classes. Regular rebalancing—at least annually—is essential.

 

Review existing holdings before adding a new fund. “Ensure that each fund adds value to your portfolio,” says Raghaw. 

US market exposure would have boosted returns
	2021	2022	2023	2024	2025
Sensex	22	4.4	18.7	8.1	9.1
S&P 500	26.9	-19.4	24.2	23	16.5
Source: pbcs.in