An investor can aim to provide diversification in their investment portfolio by selecting different types of funds, whether that be by asset class, sector or region. But when those funds invest in some of the same underlying stocks this will expose the portfolio to a holdings overlap.
Choosing to invest in both a technology fund and a global equity fund managed by different fund houses might provide an investor with some diversification, but if those funds both invest in some of the same stocks as part of their top holdings (such as shares of Apple and Microsoft), the investor's portfolio might not be as diversified as they first thought.
While a small amount of holdings overlap is okay, a high amount of overlap can increase a portfolio’s expected volatility and/or alter the expected returns.
Holdings overlap is a hidden risk in portfolios and can be a problem for risk-averse investors who want to limit their concentration in one sector and/or overall portfolio volatility.
Being aware of the top 10 holdings overlap in a portfolio can help investors be more aware of what exposure they have across a single stock and therefore the potential impact it could have on investment returns if that stock had a sudden increase or decrease in value. An investor can make an adjustment to their portfolio if they feel overexposed to any single stock, by replacing one of the funds with a similar fund that does not carry that stock as a top holding.