Fund overlap is when an investor owns different ETFs or mutual funds that hold positions in the same stocks. For example, an investor owns a technology fund which owns Apple and Microsoft. That same investor also owns an S&P 500 index fund, which owns Apple and Microsoft. Here we have a situation where the investor owns two different funds, but both funds own two of the same stocks.
Fund overlap between SPY & QQQ
Fund overlap is a hidden risk in portfolios because it means the investor may not be as diversified as they thought. Let’s look at two of the largest index funds to illustrate our point. SPY is an index fund representing the S&P 500. QQQ is an index fund representing the NASDAQ 100. Take a look at the top 10 holdings for each fund:
The top four stocks are identical! This can be a problem for risk-averse investors who want to limit their concentration in one sector, and overall portfolio volatility. Stocks like Apple and Facebook are historically more volatile than stocks like Johnson & Johnson and JP Morgan Chase. As a rule of thumb, technology stocks are considered to be the highest risk/highest reward segment of the entire market.
Let’s look at an example
Knowing this, a moderate investor may put 30% of their money in a technology fund like QQQ, and 70% in an S&P 500 fund like SPY. Let’s break down what that would look like with a $100,000 portfolio. With $30,000 invested in QQQ the exposure to the top four stocks looks like this:
|Top 4 stocks||Fund Weighting||Dollar Allocation|
With $70,000 invested in SPY, the exposure to the top four stocks looks like this:
|Stock||Fund Weighting||Dollar Allocation|
That means, in total, the investor has the following allocations:
|Stock||Total allocation ($)||Total allocation (%)|
20% of the portfolio is dedicated to just four stocks, and they are all tech stocks! This is an example of fund overlap in action and the portfolio will now be prone to greater volatility than expected. So what can an investor do to protect themselves from fund overlap? First, you need to be aware of it.
A free website to use for your research
There are plenty of websites out there that will calculate fund overlap between various funds. We really like this one. Here are the results of our fund overlap screen between SPY and QQQ:
Notice that 85% of the holdings in QQQ are also held in SPY. So any investor who is pairing SPY with QQQ needs to be sure they are weighting QQQ appropriately. If you are an aggressive investor, then giving a fund like QQQ a higher allocation makes sense. But if you are a conservative investor, you may want to consider avoiding QQQ all together. After all, if you own the S&P 500, you already own 85% of the stocks held in QQQ anyway.
In conclusion, fund overlap is when you own different funds, but those funds own the same stocks. While a small amount of fund overlap is okay, too much of it can really damage your portfolio. A high amount of fund overlap can increase your portfolio’s expected volatility and/or alter your expected returns. In addition, fund overlap can lead to higher trading costs in the future. The bottom line is fund overlap is a hidden risk in your portfolio, and you should know how to find it.
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