PLANADVISER - September/October 2021 - 7

Too Much of a Good Thing:
Unwinding a Concentrated Stock Position
Thomas Lee, CFA
Chief Investment Offi cer, Equities and Derivatives, Parametric
Single-stock concentration can increase a portfolio's risk while
squashing the benefi ts of diversifi cation. Following a methodical
diversifi cation approach can decrease concentration risk over time.
A
massing a large exposure to a single stock may
not elicit much concern from an investor. After
all, many investors fi nd themselves holding
large, concentrated stock positions resulting
from good fortune such as equity-linked compensation,
an inheritance, or the sale of a business.
As the saying goes, however, you can have too much
of a good thing. A heavy concentration of a single
stock can increase a portfolio's risk while reducing
diversifi cation benefi ts.
Unwinding a concentrated single-stock position can be
challenging. For taxable investors, liquidating shares
means confronting capital gains taxes. Selling stock
involves a trade-off between the known up-front tax
and transaction costs and the uncertain future benefi ts
of risk reduction. For many investors, capital gains
taxes as high as 37% may seem too high a price to pay
for diversifi cation. However, it is possible to reduce a
portfolio's single-stock concentration risk over time using
a separately managed account (SMA) to alleviate an
investor's risk and tax exposure.
THE DOWNSIDE OF A CONCENTRATED
SINGLE-STOCK POSITION
It's common for investors to fi nd themselves holding a
concentrated single-stock exposure. Sometimes, the stock
position is that of a current or former employer; other
times, it's the result of a merger or acquisition. As we've
witnessed with technology shares, the stock may have
achieved its dominant position merely by outperforming
other holdings.
Investors with concentrated stock positions face the risk
that a change in the fortunes of a single company could
jeopardize their fi nancial well-being. (Simply ask former
employees of Theranos or Enron.)
Because a concentrated stock portfolio can generate
massive underperformance, most advisors typically
recommend that clients restrict single-stock positions to
no more than 10% of portfolio value.
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REDUCING CONCENTRATION RISK IS BEST
APPROACHED IN STAGES
Whittling down a hefty stock position is easier when
tackled over time. Immediately liquidating a concentrated
stock portfolio typically results in a high tax bill and lower
long-term portfolio returns.
Instead, the process can start with a staged diversifi cation
strategy. This methodical approach establishes rules
that dictate when portions of concentrated shares can
be sold, based on gains or losses in the stock's price. A
staged diversifi cation strategy enables investors to reduce
concentrated stock holdings over multiple years while
paring portfolio risk.
At the same time, an investor can establish an SMA and
invest stock sale proceeds into the account, which allows
them to spread realized gains across multiple years.
The SMA can also be customized to provide broadcap
exposure while building the portfolio around the
concentrated stock position. For instance, for an investor
with an overly large tech exposure, the SMA can exclude
the technology sector. An investor's target exposure
can then be adjusted over time as the tech position is
reduced. Realized losses in the SMA can be used to help
off set taxes resulting from the sale of the concentrated
technology stock.
THE BOTTOM LINE
Many investors feel loyal to a stock that has performed
well, believing that past performance is indicative of future
returns. The prospect of facing capital gains taxes can act
as an additional deterrent.
But holding onto a concentrated stock position is risky
and may put your long-term fi nancial goals in jeopardy.
Investors can work with their advisors to reduce risk by
establishing a tax-deferred diversifi cation plan that may
increase a portfolio's value over time and reduce singlestock
concentration.
PLANADVISER - September/October 2021

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