Diversified? Think again. Your mutual funds may be secretly cloning each other

Investors often choose multiple mutual funds to diversify their portfolios, assuming that it limits risk and ensures varied exposure to different sectors and asset classes. However, mutual funds in India may not always offer the diversification you think they do. In reality, many mutual funds have overlapping investments, leading to unintentional "cloning" in your portfolio. This overlap can result in a higher concentration in certain stocks, sectors, or themes, which impacts the overall risk-reward balance.

For instance, large-cap equity funds in India predominantly invest in blue-chip companies. If you hold two large-cap funds, the probability of both holding stocks like HDFC Bank, Reliance Industries, or TCS is high. A thorough comparison of mutual funds reveals that some equity funds have up to 60-70% portfolio similarity in terms of stock allocations. Let’s consider an example:

- Suppose Fund A has ₹2 lakh invested in Reliance Industries, and Fund B also allocates ₹1.5 lakh in the same stock. If market fluctuations impact this stock adversely, the combined ₹3.5 lakh investment will bear the brunt, negating diversification benefits.

Research by financial analysts indicates that nearly 80-90% of large- and mid-cap mutual funds in India have overlapping holdings. While this is not inherently bad, it defeats the primary objective of diversification. Cloning leads to a situation where an investor unknowingly carries concentrated risk associated with specific areas of the market.

Summary:

When investors buy several mutual funds, the expectation is to balance risks and returns via diversification. However, many funds end up holding similar securities, especially in large-cap and mid-cap categories. This unintentional "cloning" can lead to high exposure in a handful of stocks or sectors, leaving the portfolio far from diversified. Investors should carefully analyze portfolio overlaps before making investment decisions.

Disclaimer:

The information provided is for educational purposes only. Investments in financial markets are subject to market risks. Investors are advised to perform comprehensive research or consult financial experts before making any investment decisions that suit their financial objectives and risk appetite.


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