Money Matters: Managing investment diversification and stock overlap

One of the basic rules to manage investments and recommended by most financial advisors and money managers is diversification. Owning a group of individual stocks can create diversification; but when analyzed more closely, you may discover there is less diversification than you thought. More often, individuals select several mutual funds believing they are diversifying their portfolio only to find out that the funds perform very similarly. The cause may be due to the underlying holdings are very similar rather than unique.

There are several tools available in the market that will determine the amount of "overlap" when comparing several mutual funds. As an illustration, I calculated the overlap between ten domestic funds at Fidelity. Included in the ten were balanced, large growth, large value, blue chip, aggressive growth, contra, equity income, low-priced, and a basic stock fund. By the name of the various funds, it would be a natural assumption that if money were placed in each of these ten funds, the holdings should be different. This does not always hold true.

Here are some of the results. ExxonMobil was in five of the ten funds ranging between 2.5% and 5.72% of the fund's value. It was in both growth and value funds as well as the contra fund. Hewlett-Packard was in seven of the ten funds. The percent of the fund's value this represented by this stock ranged from 1/4% to 3.83%. Next was JPMorgan Chase and McDonald's being in six and seven funds respectively. This was followed by AT&T and Oracle. Oracle was in the low-priced fund, the large cap growth, the balanced and contra funds.

By studying these results, you may be led to believe there is little difference between many of the funds, so why use more than one domestic fund. In my opinion, these results were created in part by the sheer size of the funds reviewed. These funds have assets from $1.7 billion to $75 billion under management. When funds reach this size, the available investment options are reduced and can result in both the growth and the value fund owning many of the same investments.

To take this one step further, I reviewed the overlap of stocks on three different energy/natural resource funds, each from a different fund family. Since each fund is in the energy sector, the available investment selection is limited and more overlap might be expected. The Morningstar® overlap report shows each of the three funds own almost the same top 15 securities which account for over 25% of the assets. With this amount of overlap and many of the remaining positions also being held in two or more of the funds, you might conclude the performance would also be similar. However, year-to-date performance through April 30th clearly shows overlap may not be as important as some believe. One fund was up 10.51%, while the second was only up 6.47% and the third had increased in value 1.03%. Obviously, there are other factors than stock selection which lead to great returns.

Stock overlap is just one tool of the industry, and the result of determining the overlap between funds is only part of the story. The fact the overlap may be high does not always mean the performance will be the same and owning only one of the funds is the best option. Owning different funds knowing they may own similar holdings is okay, as long as your intent is not to create greater diversification.

Managing investments is a blend between science, art, and occasionally luck. Those of you managing your own investments should do so only because you devote the required time and have the knowledge to do so. Without these two key factors, you should hire someone like my firm or one of the other area firms to manage your holdings. But, be certain they are going to manage the holding and not just sell you new positions.


Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville, TN 37801. Be sure to mark your envelope Money Matters.

Doug Horn, CFP, is an area financial planner with more than 24 years financial experience and founder of Quality Financial Concepts, located in downtown Maryville on Broadway.

Doug Horn, CFP, Registered Investment Advisor in Tennessee and Texas and Registered Principal, Branch Office of and Securities offered through CUE Financial, Member FINRA, SIPC.

© 2008 All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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