Coping With Concentrated Positions

Many high net worth individuals have concentrated investment holdings. Perhaps Dad worked his whole life for a single company, and now the family has most of its net worth tied up in its stock. Or, a corporate officer might have to maintain an inordinately large position of company stock for political reasons.

Sell If Possible

It is almost always desirable to sell concentrated stock positions, because the risks of continuing to own them outweigh the benefits of their projected returns.

Adding pressure to this decision, the ticking clock runs out on the Bush tax cuts in 2010. Capital gains taxes are presently as low as they are likely to be in our lifetimes. While it is always distressing to cut a big check to "United States Treasury," the current one-time 15% Federal tax hit may be the best offer we are going to get.

When Selling is Impossible

At Conservative Wealth Management, we design custom portfolio-based solutions for clients with concentrated holdings. The goal is typically to reduce downside volatility by using the the rest of the portfolio as a buffer.

Hypothetical Example: A family has 50% of its liquid net worth tied up in Microsoft. In order to manage the high volatility, they might put the rest of their holdings in short-term bonds. This would give them the portfolio shown below (all calculations courtesy of Quantext QPP Monte Carlo simulator, derived from data 1/31/2003-1/31/2007).

 

 

Now, imagine that they wanted to keep this same level of volatility (a standard deviation of no more than 15.2%). Can they do better?

Consider the portfolio below:

 

 

This time, instead of relying only on bonds, we surround the Microsoft position with stocks from the consumer staples sector and commodities.

Now the portfolio's volatility is the same or lower than before, while the returns are significantly higher.

This simplified example shows the power of targeted diversification strategies to potentially improve the risk-adjusted returns for individuals with concentrated stock positions. (Please note that this example is for illustration purposes only and does not constitute specific investment advice.)