Minimize portfolio overlap

Monday, February 27, 2017|Managing Investment Risk|
  • Minimize Portfolio Overlap

Too many portfolios are overloaded with similar investments. Sadly, few investors know very much about overlap.

A frequent investing theme of today is owning more than a dozen mutual funds. Often purchased over the years with little thought as to how the collection fits together, if at all.

Owning several funds can result in creating significant “overlap” of securities. That is, individual holdings within the mutual funds are often the same, or quite similar.

While fund names differ, their holdings may not. For example, mutual funds buy from a short list of bank stocks.

Having several accounts can also result in owning many of the same stocks in each. This may tilt your portfolio in one or more asset type or sector.

However, I hardly see anything written about portfolio overlap. No wonder most investors have little or no knowledge of the implications of overlap.

I highlight what can happen:

  • Owning a collection of funds heavy on overlap reduces portfolio diversification.
  • Overlap increases if you choose funds from similar investing styles and sectors.
  • Portfolios that overindulge on overlap can affect their long-term results.

Some portfolios I’ve reviewed were sporting more than 40% overlap. I’ve seen issues arise with as little as 10% overlap.

Think of your overlap in this fashion:

Overlap Factor Overlap Range Portfolio Implications
Low Under 10% Little required
Noticeable 10% to 20% Needs tweaks
Medium 20% to 30% Cracks showing
High 30% to 40% Serious problems
Excessive Over 40% Start fresh

 

I present five straightforward ways to reduce the impact of portfolio overlap:

1. Design personal asset mix targets and invest within them.
Something few investors have or follow.

2. Focus on portfolio diversification to achieve the least duplication.
Start by analyzing stock similarities in your mutual funds’ top holdings.

3. Be careful when buying funds from the same manager or provider.
This is when portfolio overlap can reach its highest levels.

4. Invest in Exchange Traded Funds (ETFs) and index funds.
Up to twelve ETFs with low or no overlap should suffice to populate most asset mix.

5. Reduce the number of investing accounts to a minimum.
Then concentrate on how well the investment selections mesh together.

Probe the overlap factors affecting your nest egg. Try to keep duplicate and similar holdings as low as possible.

Limiting overlap also reduces portfolio risks. You can’t avoid all overlap as many funds invest in the same companies.

Your primary mission is to minimize overlap, not eliminate it. Don’t allow the consequences of overlap to shortchange your portfolio.

About Adrian Mastracci, Discretionary Portfolio Manager, B.E.E., MBA  My expertise in the investment and financial advisory profession began in 1972. I graduated with the Bachelor of Electrical Engineering from General Motors Institute in 1971. I then attended the University of British Columbia, graduating with the MBA in 1972. I have attained the “Discretionary Portfolio Manager” professional designation. I am committed to offering clients the highest standard of personal service by providing prompt, courteous and professional attention. My advice is objective, unbiased and without conflicts of interest. I’m part of a team that delivers comprehensive services and best value in managing client wealth.

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