05/05/2000

Do Your Mutual Funds Overlap?

The market has certainly given us a wild ride recently. The range between the highs and the lows has been considerable. How did your portfolio perform throughout the ups and downs? Ultimately, of course, the gains or losses in your mutual funds were based on the performance of the underlying investments in the fund -- e.g. the stocks. I find it curious though that a majority of mutual fund owners, in my opinion, do not have any understanding of the stocks held in the funds they own. Do you need to know every stock in a fund? Of course not. However, it is important to know what the major stock holdings are and it is advantageous to know how much overlap you have in the holdings among all of your funds.

In this article, I will discuss stock overlap is and why it is an important assessment tool.

Before I discuss overlap, let me point out an easy way to know what your fund manager has invested in -- look in the annual or semi-annual report. Yes, you get them in the mail from the fund company. However, if you are like most people you assume it’s a bunch of incomprehensible stuff and you throw it away. But the annual report is a more interesting document than the prospectus you are given, by law, when you purchase a fund. The reason it is more interesting is precisely because you can actually see what you have invested in. I think it is fun to know that you own some Microsoft, Cisco, General Electric, Harley Davidson, Home Depot, AOL, Rambus, Bristol-Meyer or whatever.

So the next time you get an annual report open it up and take a look. You will be fascinated to learn what you own.

Even if you have taken the time to look at the stocks in your funds, chances are you have not calculated the amount of overlap that exists. Overlap is the amount of a stock -- say Microsoft stock -- owned by all the mutual funds in your portfolio. For example, you may own a balanced fund, a growth fund, a technology fund and a global fund and all four of these funds might have Microsoft as a major holding. Chances are, you purchased these different targeted funds, and perhaps from different fund companies, seeking diversity only to end up holding a great deal of the same investment. Thus, you would not have the diversity you wanted and needed. That is one good reason to know the amount of stock overlap in your mutual fund portfolio.

Let’s take a closer look at mutual fund overlap through a hypothetical portfolio -- that of Mary & John. Sample:

• John’s IRA: Aim Charter - $11,700; Aim Aggressive Growth - $5,300
• Mary’s ROTH Conversion: Janus Global Tech - 9,100; Janus Worldwide - 7,000; Janus Enterprise - 4,400
• Joint Funds: Washington Investors - $7,800; Growth Fund of America - $3,200; Balanced - 6,700
• John’s 401k: Putnam Vista - $21,000; Putnam Voyager II - $14,900; Putnam New Opportunities - $18,300; Putnam Growth & Inc. - $12,800; Putnam International Growth - 7,400
• Mary’s 401k: Vanguard S&P Index - $17,000; Vanguard European - $7,000; Vanguard Mid Cap - $13,000; Vanguard Life Strategy Mod. Growth - $8,000

Total -- 17 funds

The major fund overlap in the above portfolio is as follows:

• Texas Instruments -- owned by 9 of the funds
• Veritas Software - owned by 8 funds
• Microsoft -- owned by 7 funds.
• Cisco -- owned by 7 funds
• Sun Microsystems -- 7 funds
• Lucent Technology -- owned by 6 funds
• General Electric -- owned by 6 funds

The list goes on and on and includes a total of more than 25 stocks that are owned by more than one fund. Surprised? Actually, stock overlap is quite common. The goal is to make sure you do not have too much.

Now in this particular portfolio, no one stock represents more than 2% of the total portfolio. For example, Microsoft is the largest holding, representing about 1.31% of the total portfolio or only just over $2,200. So the overlap of an individual stock in this portfolio is relatively insignificant. While no one stock has an overly dominate place in this sample, it is interesting to learn that, collectively, you are looking at a technology-centered portfolio. That is because most of the stocks listed above are tech stocks and the overlap analysis continues showing mostly all tech/communication stocks. Now by the design or intent of the investors, the above portfolio does not look to be a technology focused portfolio. However, by default it is technology focused. Depending on the goals, market outlook, and risk tolerance of the investors, this may be good news or it may be bad news.

John and Mary Sample have spread there investments between and among five different fund families -- AIM, Janus, Putnam, Vanguard and American. Doing so has probably reduced the amount of stock overlap. Why? Well, it is my experience, that fund managers within a fund family share ideas, expertise, research, etc. So if one fund manager likes a stock, he/she shares the enthusiasm with the other fund managers "in the family." Before long you can see that most of the funds in a family have several of the same holdings. So if overlap is a concern to you, you can reduce try to reduce it by exploring different fund families.

Overlap is generally neither good nor bad, it is neutral. Part of the reason overlap happens is that fund managers like certain companies for the same reason. Thus, you see Microsoft held by numerous funds. The key is to take a look at the holdings in your portfolio and know that you have the kind of overlap you want and if not, take action to reduce it, if it is considerable. Knowing your holdings and overlap might make all the difference in achieving solid gains or reducing your losses the next time the market swings.

Please send questions or comments to dcoffin46333@wradvisors.com.