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What is Fund Overlap? Example & How it’s Used

Last updated 03/19/2024 by

Alessandra Nicole

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Fund overlap occurs when an investor holds multiple mutual funds or ETFs that invest in the same or similar securities. Excessive overlap can diminish diversification, potentially leading to concentrated positions and unseen risks for the investor.

What is fund overlap?

Fund overlap describes a scenario where an investor possesses shares in multiple mutual funds or ETFs, each with holdings that intersect or replicate each other. For instance, owning both an S&P 500 index mutual fund and a technology sector ETF could result in substantial overlap, especially with stocks like Meta (formerly Facebook), Apple, Amazon, Netflix, and Google, common to both funds’ portfolios.

Fund overlap explained

Fund overlap can limit the advantages of diversification, potentially leading to overly concentrated positions in a few companies’ shares. This phenomenon reduces the effectiveness of spreading risk across various assets and may expose investors to unforeseen risks.

How fund overlap impacts investors

While minimal overlap between funds is customary, excessive overlap can subject investors to unexpectedly high levels of sector or company-specific risk, distorting portfolio returns when measured against a relevant benchmark.

Managing fund overlap

Regularly reviewing individual fund holdings, either quarterly or annually, aids in comprehending each fund’s strategy and identifying duplicate securities across different funds. By recognizing overlapping securities, investors can make informed decisions about purchasing fund shares.

Reducing overlap in investment portfolios

To mitigate overlap, investors can compare the top holdings of different funds and consider replacing a fund that excessively overlaps with similar funds that do not share those top holdings. Additionally, evaluating sector concentrations across various funds helps in weighing the advantages and risks associated with increased exposure.

Overweighting sectors

Overweighting refers to an investment portfolio holding an excessive amount of a particular security in comparison to its weight in the benchmark portfolio. This strategy might be employed in actively managed portfolios to achieve excess returns.
Securities are often overweighted based on a portfolio manager’s belief in their outperformance compared to other securities in the portfolio. Such overweight positions can aim to hedge or reduce risks associated with other investments.

Equal weight and underweight recommendations

Conversely, equal weight suggests that a security is anticipated to perform in line with the index, while underweight indicates an expectation that the security will lag behind the index in question.

Fund overlap and diversification

Both fund managers and investors prioritize diversification across various asset classes, allocating percentages within stocks, bonds, real estate, commodities, ETFs, short-term investments, and alternative asset classes. This diversification aims to minimize risk by selecting investments that demonstrate low return correlation.
In the realm of bonds, investors diversify their portfolio by selecting from investment-grade corporate bonds, U.S. Treasuries, municipal bonds, high-yield bonds, and other fixed income securities.
Here is a list of the benefits and the drawbacks to consider.
  • Increased knowledge of portfolio holdings
  • Enhanced awareness of potential overlap risks
  • Opportunity for informed decision-making regarding fund investments
  • Potential complexity in managing multiple fund holdings
  • Difficulty in regularly tracking and analyzing fund contents
  • Possibility of making errors in identifying and rectifying overlaps

Frequently asked questions

What are the risks of fund overlap?

Fund overlap can lead to concentration risk and reduced diversification, potentially exposing an investor to heightened market volatility or sector-specific downturns.

How can investors mitigate fund overlap?

Investors can reduce overlap by regularly reviewing fund holdings, comparing top holdings, and considering alternatives with less overlap in securities.

Key takeaways

  • Fund overlap diminishes diversification and can lead to concentrated positions, potentially posing unforeseen risks.
  • Regularly reviewing individual fund holdings helps in identifying and managing overlap, aiding in informed investment decisions.
  • Diversification across various asset classes is vital for risk management in investment portfolios.

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