Reviewing your investments and diversifying your portfolio away from concentrated holdings can help minimise the risk of losses.
Download our entrepreneur’s guide to wealth structuring
For many business owners, it’s not unusual to have a significant amount of wealth tied up in a single asset. Whether through the ownership or sale of a business, a large shareholding, or even an inheritance, the growth of a concentrated investment can be the source of generous rewards – as well as significant risks.
“Many people spend years focusing on their careers and then find they have amassed a large amount of wealth that is tied to a single asset,” says John Younger, managing director and head of client and business strategy at RBC Wealth Management in London. “It’s at this point that you want to know how to preserve it for the future.”
For most entrepreneurs, the primary source of wealth and income is their business. For anyone in this situation, it is important to take a holisitic view of your financial affairs and consider the different options available for protecting wealth in the event of a market or economic downturn. Similarly, for those who have concentrated investments in a single asset – perhaps through the sale of a business or the growth of an investment – steps should be taken to protect your wealth for the future.
While the growth of a concentrated investment might have created substantial wealth in the past, there is no guarantee this will continue in the future. Therefore it is important to be aware of the potential risks to this over the long term, says Guy Huntrods, head of investment specialists and execution at RBC Wealth Management in London.
“Those who hold onto these positions over time may experience downward price pressure from both company-specific and outside influences, which could derail future plans and exit strategies,” Huntrods says. “But with careful consideration and planning, your ride could be made smoother and more value could be derived from the asset.”
Mitigating the risk of loss has its benefits during all market and economic conditions, although it is perhaps even more important in the current environment. Financial markets have experienced a prolonged period of growth in the years following the 2008 financial crisis owing to ultra-low interest rates and aggressive stimulus measures.
Frederique Carrier, head of investment strategy at RBC Wealth Management in London, says all business cycles eventually show signs of old age. “As the business cycle becomes more and more mature, the chances of a market correction become more likely and this can represent a large risk for anyone with a large position in a single company.”
For some people, there is a disconnect between the work involved in building a business or amassing a large asset and the work to protect it from unforeseen events. “Many people know their company best, but what if something happens, such as an illness, a political event, a regulatory change or a market correction?” Huntrods says. “Threats can appear unexpectedly, so it is important for you to think about what you might need to do to protect or diversify your investments and be aware of the potential strategies available to you.”
The simplest solution to a concentrated investment is to sell some of your shares and invest elsewhere. But for some people this is neither possible nor desirable – especially business owners.
However, for those who have large shareholdings in listed companies, this may be because the securities cannot be sold until some point in the future, or because they want to retain certain privileges, such as voting rights. Others may be reluctant to sell as a result of an emotional attachment to the company or an expectation that the share price will rise in the future. For those whose wealth is tied to a successful but unlisted business or perhaps a large property portfolio, the situation is more challenging because it might not be desirable to sell a portion to outside investors.
“People can have several reasons for not wanting to sell the shares they hold in a company, whether it’s because you are emotionally attached to them or because there may be negative financial implications from doing so,” Younger says. “You need to find the most suitable solution or process, so that you can receive the best possible outcome.”
Divesting entirely from an asset doesn’t always make sense, particularly in the case of a family business. In situations where it is necessary to continue to hold the asset, hedging strategies can potentially act as insurance against any fall in the value of a stock. Alternatively, you could borrow against your portfolio and use the loan to invest in other assets. For business owners who do not want to sell shares in their company to investors, one option is to build a diversified investment portfolio from the income they draw from their business.
Concentrated investments pose plenty of challenges, and solving the problem is not always straightforward and will need to take into account your specific circumstances. But whether it means selling down a position and diversifying into other assets, or using hedging strategies, reducing concentration risk can play a vital role in protecting your wealth now and in the future.
This publication has been issued by Royal Bank of Canada on behalf of certain RBC ® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.
The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.
Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. The Channel Island subsidiaries are not covered by the UK Financial Services Compensation Scheme; the offices of Royal Bank of Canada (Channel Islands) Limited in Guernsey and Jersey are covered by the respective compensation schemes in these jurisdictions for deposit taking business only.
We want to talk about your financial future.