What Is A Concentrated Risk Position?

There are many definitions! Our experiential definition is based on what is archetypical of most clients when we first meet:

Generally, our clients’ wealth development emanates from a singular source, their ongoing affiliation with their employer. A concentrated risk position means that held shares of the employer stock plus the “In The Money Value” of vested stock-based compensation can represent 60% to 80% or more of their total investment portfolio.

Regardless of what technical definition one wants to put forth, the archetypical pattern above is recognizable as being a concentration of many kinds of risk. In portfolio allocation terms, the chief risk is known as a concentrated single-security risk position.

Is Single-Security Concentration Dangerous, Bad, or Something to be Avoided?

Bill Gates has likely not been heard to complain about his concentrated position in Microsoft. Concentration can lead to tremendous wealth development! So, a concentrated position is not necessarily dangerous or bad. In fact, Warren Buffett and Charlie Munger have said that real wealth is built through concentration.

On the other end of the spectrum, one need only think about WorldCom, Enron, or Arthur Andersen – companies which no longer exist. Or, consider SuperValu (SVU) – an active company. In the decade before it was sold to United Natural Foods in 2018, SuperValu’s stock lost 90% of its value. Companies like these do not have to go out of business to wreak financial havoc on a leader’s wealth. One of the most memorable days of my life as an advisor was having breakfast with a prospective client who was then a Senior Leader of SuperValu when their stock plummeted from $49/share to $9/share in just 18 months and then to $2/share sometime thereafter. This is what this prospective client told us:

“All my grants are underwater and will surely expire out of the money. My Long-Term Incentive Plan (LTIP) is worthless, my held shares have declined more than 80%, and there is no hope of receiving a cash bonus. All I am working for is my base salary and, in addition, I must now terminate the employment relationships of my friends and co-workers whom I have mentored for ten or more years.”

Let’s revisit the question: Is concentration bad, dangerous, or something to be avoided? That depends on a client’s specialized circumstances and risk makeup. We maintain that concentration is simply a specialized portfolio position to recognize, discuss, quantifymonitor, and tax-effectively manage.

Is Reducing Concentration Risk a Tax Decision or a Risk Control Decision?

With millions of dollars vaporized, our former SuperValu officer would say diversification would certainly have been a risk control decision. Because we all hate paying taxes, most (but surprisingly not all) new clients say diversification is a tax decision. We recently asked a wise old accountant friend if a mutual client had room to recognize $675,000 of capital gain to continue diversification of her portfolio. His answer was priceless:

“You know as well as I do: diversification is not a tax issue. It’s a risk issue! For the sake of diversification, YES, she has room to recognize the gain.”

We understand that some professionals will fervently argue that diversification is a tax decision. The core question is this: what does the client believe? Exploring this question is step #1 with all new clients.

How do I decide when to diversify?

If diversification is the chosen step, there are several factors that should be known and decisions that should be made before any action is taken. If these issues are thoroughly discussed, then when the optimal time comes for diversification, the proper steps can be triggered at the optimal time. In fact, there is so much to unpack here, that we will delve into several of these decisions in future blogs. In the meantime, here are some topline considerations:

  • What is the destination for cash emanating from a sale in the concentrated position?
    • An officer must be knowledgeable about, and comfortable with (if not enthusiastic about) where cash from sales of the concentrated position will be invested and why they will be invested as decided. This is essential to properly time stock-to-stock diversification moves.
      • A bit off-topic yet related, all our clients know, proactively, exactly where net proceeds from all equity vesting or option exercising will be directed months and sometimes years prior to the actual vest or exercise event.
  • How much unrealized gain (or loss) resides in both the concentrated and diversified positions?
    • To create a diversification strategy in taxable accounts, one must first rank every held share of employer and non-employer stock from the highest to the lowest percent of embedded/unrealized gain or loss.
    • Even if risk reduction is the primary reason for diversification, paying tax is a hard cost, and thus given the fact that there are many different methods of executing the diversification strategy, one absolutely needs to do so in the most tax-efficient method consistent with client objectives.
  • Both historically and presently, how is the concentrated company stock performing relative to the broad market?
    • Optimal diversification decisions for held shares are frequently not made based on the employer stock hitting a certain price per share. One must monitor the directional differential between the employer stock price per share relative to the broad market. The greater the differential between concentrated shares and the broad market, the easier it is to make a diversification or hold decision.
    • We nickname this relative differential “JAWS,” because periods of time for optimal stock-to-stock diversification can sometimes present themselves for only a matter of days.
  • For some clients, this relative valuation monitoring is simply too tedious, and a better way forward might simply be to begin systematic, selling out of the concentrated position. This is likened to “reverse dollar-cost averaging.”

 

Different advisors have different perspectives on their roles and relationship with their clients. Many advisors seem to want to have “all the answers.” Our clients are highly intelligent and well-educated decision-makers and leaders. We do not attempt to have all the answers, but we do try to ask some very good questions. After all, working out from under a concentrated position is more art than science. Our job is not to bully a client; it is to provide perspectiveoptions, and insight, so our clients are empowered to make high-qualityinformed decisions and then live with the consequences of their decisions.

If you have a concentrated wealth position that you want to discuss, give us a call! We may not have an immediate answer, but we do have the experience to ask the right questions and, if desired, to formulate a tax-efficient diversification strategy suitable to your objectives.

Stoddard Barnhill

Phillip Barnhill

Share
Share on facebook
Share on twitter
Share on linkedin
Share on email

The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. The team and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

Third-party links and references are provided solely to share social, cultural and educational information. Any reference in this post to any person, or organization, or activities, products, or services related to such person or organization, or any linkages from this post to the web site of another party, do not constitute or imply the endorsement, recommendation, or favoring of The Bahnsen Group or Hightower Advisors, LLC, or any of its affiliates, employees or contractors acting on their behalf. Hightower Advisors, LLC, do not guarantee the accuracy or safety of any linked site.

Hightower Advisors do not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client’s individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor for related questions.

This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.

About the Authors

Phil Barnhill, CLU

Private Wealth Advisor
Director of Risk Management

Stoddard Barnhill, CFP®

Private Wealth Advisor

For nearly 25 years Phil has worked exclusively with senior leaders of public and large private companies. Over the past six years Stoddard has been carefully mentored in this niche market, leading to a highly-specialized practice knowledge within the team. This focus on corporate executives and their family dynamics comes with significant insights into executive compensation, stock concentration, equity monetization, and the full life-cycle of a career in the C-Suite.

Looking for something specific?

Play Video
Play Video
Play Video
Play Video
Play Video
Play Video
Play Video
Play Video