- Fund overlap happens when an investor owns multiple mutual funds or ETFs that share the same holdings.
- This can result in your portfolio being less diversified, amplifying the risk of losses in a down market.
- To prevent excessive fund overlap it is important to review your portfolio regularly.
Diversification is one of the most important principles of investing. By allocating your assets in a wide range of securities within and across different asset classes, you reduce your exposure to risk and
One way investors achieve diversification is by holding a variety of mutual funds and exchange traded funds (ETFs). However, if you choose this route, it’s important to make sure that fund overlap isn’t undermining your effort to create a diversified portfolio.
What is fund overlap?
Fund overlap occurs when an investor owns multiple mutual funds, ETFs, and sometimes individual stocks, with overlapping positions.
An example of this would be owning the popular Invesco QQQ ETF, which tracks the Nasdaq 100 Index, and the Vanguard Total Stock Market
(VTI). Both have significant positions in many of the same companies. For instance, as of mid-2022, each had Apple, Microsoft, Amazon, Alphabet, Tesla, and Meta in their Top 10 holdings.
“One of the biggest dangers of extreme overlap is the possibility of having heavily concentrated positions,” says Joshua Lutkemuller, a chartered financial analyst (CFA) and head of investment strategy at Strongside Asset Management. “An investor might unknowingly create a portfolio that is heavily concentrated in weight to just a few names, even though they might have the illusion of diversification because they own several funds.”
What causes fund overlap?
Every fund you invest in has an investment strategy and goals that are described in its prospectus. The fund managers select securities that they determine will meet their objectives. The goal of a classic equity index fund is to track the performance of the entire stock market.
Fund overlap occurs when an investor chooses funds that have different stated goals but use many of the same stocks to accomplish them.maga
For instance, a company like Tesla could appear in a fund you own focused on the environment, or one geared toward technology stocks, as well as an index fund. In such a case, a significant drop in Tesla’s shares would be felt throughout all three funds. The risk is magnified as the number of overlapping stocks in the funds you own increases.
Overlap can also leave you overexposed to specific sectors. “Each sector has its periods of underperforming or underperforming, but you want to ensure that you have the appropriate sector weights according to your asset allocation,” says Lutkemuller.
Fund overlap example
Below is an example of fund overlap using the current top holdings for SPDR S&P 500 ETF (SPY) and the Vanguard Growth ETF (VUG), two of the most popular ETFs.
Each has a different objective SPY tracks the performance of the 500 largest US companies. VUG’s goal is to track US growth stocks that are poised to outperform the broader stock market. Below are their Top 10 holdings as of June 2022:
The chart shows significant overlap that exposes an investor to an increased level of risk. Keep in mind that these are only the largest holdings and there may be even more overlap if you dig deeper.
3 ways to reduce fund overlap
While totally eliminating fund overlap in your portfolio may not be possible, it’s important to keep it in check. Here are three ways do to that:
1. Understand the fund manager
Take the time to understand who is managing the fund and try to avoid owning multiple funds run by the same manager. Fund managers implement the investing strategy and decide what to buy and sell.
“Managers have investment habits that are hard to change, and they are likely to bleed into the other funds they manage,” says Lutkemuller.
2. Use a portfolio overlap tool
Consider using a tool to help visualize where you may have overlap among the funds in your portfolio and how significant they may be. Morningstar’s fund descriptions include diagrams that help illustrate how the holdings are allocated and can be used to spot areas of your portfolio that may have overlaps. There are other options you can find with a quick search that can get the job done, including this one from the ETF Research Center.
Keep in mind that with both these tools you can get the basic information about how much two funds may overlap, but you may need to create an account or pay for more advanced information.
3. Review your investments on a regular basis
Monitoring the level of overlap is not something you do one time. You should review it at a minimum of once per year. Regular reviews are important because over time the securities in the funds you own may shift due to changes in the business environment. Funds that do not overlap now may at some point in the future.