In the annals of war strategy, few tales are as legendary, or as deceptive, as the Trojan Horse. After a tiring and fruitless 10-year siege of Troy, the Greek army appeared to retreat, leaving behind a giant wooden horse as a peace offering. The Trojans, confident of their victory, got curious about the gift and brought it inside the city walls. That night, Greek soldiers hidden within the horse crept out and opened the gates for their army, leading to Troy’s downfall.
The lesson to learn is that what appears harmless, even celebratory on the surface, can conceal hidden dangers within. A similar scenario unfolds in the world of mutual fund investing.
The Illusion of Diversification
A couple of months back, a senior executive — let’s call him Rajesh — approached us for comprehensive financial planning. He already had a diversified mutual fund portfolio, but was surprised that all his schemes, which had been doing well a year ago, were reacting similarly to market volatility. He believed that he had a robust portfolio with investments spread across nine equity schemes, held by five fund houses, and encompassing various categories, including large-cap, flexi-cap, focused, and multi-cap funds. On paper, it looked perfect.
However, when we conducted an overlap analysis, the illusion dissipated. Nearly 60% of Rajesh’s entire portfolio was exposed to just 15 stocks, the usual suspects, including HDFC Bank, Reliance, Infosys, ICICI Bank, and TCS. Despite holding multiple schemes, Rajesh had unknowingly concentrated his portfolio into a narrow basket of repeat holdings — the investment equivalent of welcoming a Trojan Horse into the fortress of diversification.
What Is Fund Overlap?
High fund overlap means that different mutual fund schemes invest in nearly the same set of underlying shares, creating a false sense of diversification. Investors assume that because they own multiple schemes, their portfolios are diversified. But often, the holdings under the hood tell a different story. Another mistake people make is trying to count overlap manually by looking at the stock names. It’s essential not only to find out the number of common stocks but also the common weight percentage.
Real-World Example: Same Manager, Same Mindset
Consider this actual case. A flexi-cap fund and a focused fund, both from the same AMC and managed by the same fund manager, have a 71% overlap in holdings, which is very high. One fund had 59 stocks, the other 33, but their top positions were essentially identical. An overlap of less than 25% is considered healthy, with lower being better in your portfolio holdings.
Even across AMCs, high overlap can persist. Among the 40+ flexi-cap schemes in the market, it’s not unusual to find two funds with a 50–60% overlap. On the other hand, you can also find schemes in the same category without any overlap. So, just choosing funds from the same or a different category does not guarantee a solution to the overlap. Occasionally, you may get lucky with minimal overlap, but without checking, you wouldn’t know which combination you’re holding.
Why Overlap Is a Problem
The most apparent risk is false diversification. You believe your risk is spread, but in reality, your portfolio has overexposure to a small set of companies.
This illusion leads to concentration risk. If those overlapping stocks underperform — as even the best companies occasionally do — your entire portfolio takes a hit, regardless of how many different schemes you hold.
Loading your portfolio with high overlap schemes makes it operationally harder to manage, with added complexity but little added value.
How to Detect and Fix Overlap
The good news is that overlap is both detectable and fixable. Several free online tools allow you to input two or more schemes and instantly see how many holdings they share, and in what proportion.
As a starting point, even some basic rules can help; for example, avoid holding multiple schemes from the same category or style. Try that each scheme you invest in is from a different fund house. Conduct a periodic review of the overlap, especially if there have been changes in the fund manager. Lastly, prioritise complementarity over quantity; each scheme should play distinct roles.
Avoid misplaced confidence
The fall of Troy wasn’t caused by brute force; it was a result of misplaced confidence in a structure that looked safe from the outside. Similarly, investors today may be confident in the number of mutual funds they hold. But confidence isn’t the same as protection. Diversification is only real when it spreads your risk and not your paperwork.
So the next time you review your investments, don’t just count your schemes. Look inside them. Because what’s hidden in plain sight may just be where your real risk lies.
Saurabh Mittal is an RIA and the founder of Circle Wealth Advisors Pvt. Ltd. Views are personal.