Sunday, January 6, 2013

What is a Concentrated Position?


Defining a concentrated position:  A concentrated position occurs when an investor owns shares of a stock (or other security type) that represent a large percentage of his or her overall portfolio.  The investor’s wealth becomes concentrated in the single position.

According to R.W. Baird (Wealth Management), depending on the volatility of the stock, and the size of the client’s portfolio, a position is often considered to be concentrated when it represents [even] 10% or more of one’s portfolio.

Perhaps we all have friends and colleagues who have an investment portfolio heavily concentrated in one particular asset class.  They may hold a concentrated equity position in one stock/asset for a number of reasons, for example:
- A lack of knowledge and/or experience in asset diversification management
- A lack of knowledge regarding general investment risk management
- Lack of liquidity to acquire other assets; i.e. buying company stock in small quantities that add up over time, e.g. via a share purchase program (payroll deduction)
- A feeling that they know their employer better than other corporations, and that holding their employer’s stock is therefore less risky than investing in other equity
- Personal emotion related to control and/or a sense of belonging – i.e. the more of my company stock I own, the more obvious my commitment to the business, the lesser my risk of termination, better my chances of promotion, higher pay, etc.

Family wealth created by holding a single stock that appreciates substantially in value over time is fairly common.  For example, senior company executives receive stock or stock options as part of their compensation, investors benefit from superior appreciation of one stock relative to the rest of their portfolio, or family members inherit a large position in a single stock.  Regardless of how the concentrated position is acquired, it results in a disproportionate allocation of wealth, which exposes the family to undue risk that should be understood and managed.

Whether investors understand the risks of holding a concentrated position or not, there is a tendency to hold onto these positions.  Corporate executives may also face insider selling constraints or concerns about how a sale would affect the market price of their company’s stock.  Other investors simply have an emotional attachment to the stock.

Many investors are concerned about the tax implications of selling.  Despite these seemingly valid reasons, there is a critical point for most investors and families where the desire for wealth, income and lifestyle preservation outweighs the need for further wealth creation.  This is especially true when investors approach retirement or life events during which they will more heavily rely on their accumulated wealth.

If you have a concentrated position representing 10% or more of your investment portfolio, speak to your investment advisor in order to come up with a risk mitigation plan, and a diversified portfolio that will be better suited to your beneficiaries in the medium- to longer term.  There are several advisors who specialize in exiting concentrated positions; find the one best suited to your financial goals and address this common investment challenge while you’re able to do so.

“The chance of gain is by every man more or less overvalued, and the chance of loss is by most men undervalued” – Adam Smith, Wealth of Nations

Vanguard white paper:  Investment Solutions and Alternatives for Addressing Concentrated Equity