Portfolio Overlap: How Sebi’s New 50% Rule Affects Your Mutual Fund Investment

Financial experts advise investors to diversify their portfolio by investing in various assets to hedge risks and protect themselves from sector specific downturns. Earlier on Feburary 26, capital market regulator, Sebi also directed asset management companies to curb overlap in portfolios at 50 per cent for sectoral and thematic funds. While fund houses have been provided a period of three years to comply with Sebi’s direction, investors should also be mindful of portfolio overlap themselves.

What Is Portfolio Overlap

In a bid to ensure that different schemes remain "true to label" and provide genuine diversification as opposed to duplicating existing strategies under different names, Sebi mandated the 50 per cent rule for fund houses. Portfolio overlap refers to the degree of similarity between two or more mutual fund schemes within the same Asset Management Company (AMC) holding identical securities, according to Sebi’s February circular. 

The overlap is calculated by considering individual stocks or securities which are common across two schemes. If Scheme 1 and Scheme 2 both have holdings of 10 per cent in Security X then the overlap would be 10 per cent. On the other hand if Scheme 1 holds 5 per cent of Security X and Scheme 2 holds 10 per cent of Security X, then the overlap will be 5 per cent.

Sebi’s new rule ensures that this total number stays below 50 per cent for specific categories, forcing fund managers to pick different stocks or use significantly different weightings. Additionally AMCs are now required to disclose the portfolio overlap for their schemes on their websites. Notably, the overlap is computed quarterly based on the average of daily overlap levels.

Often investors try to diversify their portfolio by investing in multiple funds as opposed to putting all their money in one scheme. However, if the degree of ‘portfolio overlap’ between two schemes is high the investors end up holding the same securities but under varying fund names. 

Why Investors Should Track Portfolio Overlap

Tracking portfolio overlap is crucial for investors as it can reveal whether their investments are truly diversified or simply redundant. Investors tend to believe that owning multiple funds automatically reduces risk. However, if those funds hold the same underlying securities they are not actually protected, they end up holding the same assets under different names. The duplication then leads to a  false diversification, where a single sector downturn can hit your entire portfolio at once because your different funds were all betting on the same few companies.

Additionally a high overlap can also be a matter of cost efficiency. As every mutual fund charges a management fee, holding overlapping schemes leads to the investor paying multiple fund managers to manage the same set of stocks. On the other hand, consolidating into a leaner portfolio of two to three distinct schemes is often more efficient and can curb fee leakage. 

Following the Sebi mandate, fund houses are required to provide monthly disclosures, investors can monitor these levels to anticipate shifts in your funds' strategies as they adjust to comply with Sebi’s direction with the law over the next three years.