Like many wealthy individuals and families, you have your own personal circumstances and perspectives when it comes to investing. Maybe you’re focusing on the growth outlook for a particular asset, or you’re motivated by legacy issues or the potential income from a particular asset. Whatever your motivation, holding a concentrated position in any one asset may maximize your return over the long term, but it can also increase price volatility. 

Often these investments have grown in value far beyond their initial cost basis. When determining how best to address a concentration in a particular asset, take a look at your particular situation and key goals for your wealth. Consider your personal dynamics, the tax and legal backdrop, and any emotional attachments to the asset. Define your foremost objectives when managing the asset, which may include creating liquidity, hedging the risk, diversifying, or accepting the risk of the concentration. A concentrated equity position can yield significant wealth, and many families and individuals feel a responsibility to preserve that wealth for future generations.

A single equity position comprising more than 10% of a total investment portfolio is typically referred to as a concentrated position. A concentration is frequently the result of accumulated stock shares in an employer retirement plan, an inheritance, employee stock options, or via the sale of a private company for publicly traded shares.

Dynamics to Consider

Our Strategies for Managing Concentrated Equity Positions paper provides an outline of compelling factors to consider. Before identifying a specific solution or deciding whether action is even necessary, it is vital to define the family’s foremost objectives when managing the asset, which may include creating liquidity, hedging the risk, diversifying, or accepting the risk of the concentration. 

You or your family may be hesitant to diversify such an asset as it becomes a larger percentage of your total wealth for a number of reasons. But as a result, you may be susceptible to unexpected company-specific and macro stress, business cycle risks, and tax liabilities during times when stability in returns and a source of liquidity are most needed.

What Are the Risks?

For some investors, these large holdings could increase the risk they may not meet their return objectives and other important life goals. Diversifying a portfolio may be hindered by tax and legal constraints, emotional attachments to a particular company, or other factors. How you approach the portfolio will depend largely on your personal situation, so you and your family should consult with legal and tax advisors regarding. Be mindful that in some cases the costs of maintaining a concentration, especially over time, may be more than the price of diversification.

This is a summary of the paper Strategies for Managing Concentrated Equity Positions. To learn more about this topic, download the complete article or contact a Hawthorn Investment Advisor.

Strategies for Managing Concentrated Equity Positions