How much of a portfolio overlap is acceptable?

Summary: When building an investment portfolio, many investors believe that spreading money across multiple mutual funds automatically ensures diversification. However, Dhirendra Kumar challenges this assumption. The critical question is not how many funds you hold, but how much overlap there is in their underlying holdings.

Portfolio overlap occurs when multiple funds in your portfolio hold identical or similar stocks. As Dhirendra Kumar explains, "It should be as little as acceptable because if there is a 50-70 per cent overlap, then this diversification is only optical. Actually, there is very less diversification. You think that you have bought two-three investments, but the underlying is common across the funds."

This distinction matters significantly. If you invest in three large-cap equity funds that each hold HDFC Bank, Reliance Industries and Infosys as major positions, you may feel protected by diversification. In reality, you've created concentrated exposure to the same few stocks while paying multiple expense ratios for what is essentially the same investment.

Why overlap happens: The universe constraint

The extent of portfolio overlap varies dramatically across fund categories, primarily because of the investable universe available to fund managers.

Large-cap funds face the most constrained universe. SEBI regulations (mandated in 2018) require large-cap funds to invest at least 80 per cent of assets in the top 100 stocks by market capitalisation. This restriction inevitably creates overlap. Research data shows overlap between top large-cap funds can reach 65-69 per cent, a nearly unavoidable consequence of their limited stock selection pool.

In contrast, small-cap funds operate with a much larger universe of over 5,000 listed stocks, with regulations requiring them to invest beyond the top 250 by market size. This broader mandate allows greater differentiation, resulting in overlap as low as 16 per cent between small-cap fund pairs.

Large & mid-cap funds occupy a middle ground, typically showing 40-57 per cent overlap due to their moderate stock universe. Fund categories with specific mandates, such as sectoral or thematic funds, tend to exhibit higher overlap within their focused universe.

The acceptable threshold

Financial advisors widely suggest aiming for portfolio overlap below 33 per cent, though some institutional research indicates that achieving 20-30 per cent overlap is practically unavoidable when selecting quality funds. The lower the overlap, the better; however, the category itself determines realistic expectations.

For fixed-income funds, the dynamics differ entirely. Fixed-income or debt funds, which invest in government securities, corporate bonds and money market instruments, are expected to show substantially higher duplication. As Dhirendra Kumar notes, "In case of fixed income funds, where the objective is not to diversify but to have a high quality investments, there is bound to be a substantially higher amount of duplication. But in the case of equity, the least overlap is more desirable."

This distinction is crucial: fixed-income fund overlap carries minimal risk because these funds prioritise capital preservation and high-quality instruments over diversification. Equity funds, by contrast, should maintain lower overlap to achieve true diversification across market exposures.

Consequences of high portfolio overlap

Excessive portfolio overlap creates multiple problems.

Concentrated risk: When multiple funds hold the same securities, a downturn in those stocks affects your entire portfolio simultaneously, negating diversification benefits. You lose the buffer that multiple uncorrelated investments should provide.

Fee inefficiency: Each fund charges an expense ratio, typically ranging from 0.5 per cent to 2.5 per cent annually. When funds overlap significantly, you pay these fees on duplicate exposures. For instance, paying expense ratios on three large-cap funds might equal paying 2-3 per cent annually on essentially the same stock portfolio.

Performance drag: High overlap reduces the likelihood of outperformance. With 20-30 funds holding nearly identical stocks, your portfolio effectively becomes an index, eliminating the potential alpha (excess returns) that active management offers. Research shows portfolios with over 20 overlapping funds frequently match index returns whilst incurring higher costs.

Complexity without benefits: Maintaining multiple overlapping funds requires tracking numerous holdings and performance metrics, adding administrative burden without tangible benefit.

Detection and measurement

Identifying overlap in your portfolio requires systematic comparison. Value Research provides a Fund Comparison tool that calculates portfolio overlap percentages between any two funds. Alternatively, investors can manually review the top 10 holdings across their funds and note how frequently identical stocks appear.

When conducting this analysis, focus on:

• Common stocks in each fund's portfolio
• Weight allocated to overlapping stocks
• Whether funds come from the same category

Category-specific guidance

Equity funds: Aim for minimal overlap. If holding multiple large-cap active funds, expect over a 60 per cent overlap due to category constraints. Instead, consider one quality large-cap fund plus a small-cap or mid-cap fund for genuine diversification.

Fixed-income funds: Higher overlap is acceptable and expected. Focus on different duration profiles (short-term, medium-term, long-term) or credit quality rather than avoiding overlap.

Sectoral and thematic funds: Expect naturally higher overlap with core portfolio holdings, but these should serve specific strategic purposes, not substitute for core diversification.

Practical solutions

True diversification doesn't require numerous funds. It requires strategic selection.

• Quality over quantity: Choose 3-5 well-researched funds serving different portfolio purposes rather than 15 mediocre funds.
• Asset allocation first: Allocate across asset classes (equity, debt, gold) before selecting individual funds. This architecture naturally reduces overlap.
• Diversify by category: Combine large-cap, mid-cap and small-cap funds rather than multiple large-cap funds.
• Diversify by investment style: Combine growth-oriented and value-oriented funds for style diversification, even within the same category.
• Use index funds: Complementary index fund positions deliver efficient diversification with transparent holdings and lower costs.

The bottom line

Portfolio overlap represents a hidden risk that many investors overlook whilst chasing diversification. Dhirendra Kumar's guidance remains timeless: keep overlap as little as possible, particularly in equity funds. Remember that true diversification stems from intentional selection of funds with different investment characteristics and holding patterns, not from accumulating numerous similar funds.

For investors seeking to audit their portfolios and explore their fund holdings, Value Research’s Mutual Fund Screener enables detailed portfolio analysis. The goal is to build a carefully constructed portfolio of quality funds with minimal redundancy; a far more effective approach than the diversification-at-any-cost mentality that often undermines investor returns.

Also read: Diversification can be a dummy exercise. So, check this for best result.

This article was originally published on January 31, 2019, and last updated on February 03, 2026.