Updated: 11/4/2010 9:00 AM ET|
PORTFOLIO 110: How to avoid stock overlap in your portfolio.
Investments often come in different shapes and packages, but many have similar content. Two seemingly different mutual funds can own the same stocks. In November 2010, for example, the core holdings of Fidelity Large-Cap Value (FSLVX) and Invesco Van Kampen Growth & Income (ACGKX) had several stocks in common.
There's nothing wrong with such portfolio overlap per se. However, you need know how much company-specific risk you have in your portfolio. You don't want your portfolio to be overly dependent on a few stocks. If you did, you wouldn't bother diversifying in the first place. Overlap flies in the face of diversification.
Here are some suggestions for how to make sure your portfolio is sufficiently diversified.
How to avoid overlap
If you're worried about duplication, remember these tips when building your portfolio.
1. Don't buy multiple funds run by the same manager. Zebras don't change their stripes, and managers rarely change their strategies. That's because fund managers have ingrained investment habits that they apply to every pool of money they run. So if you buy two funds by Famous Manager A, chances are you'll own two of the same thing.
2. Don't overload on one boutique's funds. Some fund families, such as Fidelity, T. Rowe Price and Vanguard, offer fund lineups that span a variety of investment styles. Other shops, called boutiques, prefer to specialize in a particular style. Janus made its name as a growth specialist; Oakmark means absolute value. Boutique families are often excellent at what they do, but it's questionable whether owning three of their funds gives you anything you won't get with one.
3. Go easy on the large-cap funds, especially if you own large-cap stocks directly. Large-cap stocks and funds make great core holdings, but they're perhaps the greatest source of overlap in many portfolios.
Why? The pool of large companies is relatively shallow. Only about 6% of all U.S. stocks can be classified as large cap. The remaining 94% qualify as mid- or small-cap stocks. So if you own multiple large-company funds, there's a high possibility of overlap. That's true if you hold individual large-cap stocks and large-cap funds, too.
4. Take the four-corners approach. Using the Morningstar style box can be a diversifier's best friend. The style box will not only tell you whether your manager is snapping up large-value stocks, but it also can lead you to funds that bear little resemblance to one another.
Value funds don't act much like growth portfolios, and small-cap funds behave differently from large-cap offerings. In style-box lingo, opposite corners attract. If you own a large-value fund from your favorite fund company, try one of its large-growth, small-value or small-growth offerings.
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