For many families, it is not unusual to have a large investment in a single company or asset. Whether through ownership or sale of a business, an employee compensation scheme, or an inheritance, the growth of a concentrated investment can be the source of generous rewards. But such investments are double-edged swords. The same asset that brought good fortune also presents a significant risk.
“Many people spend years focusing on their careers and then find that they have amassed a large amount of wealth that is tied to a single asset,” says John Younger, head of business owners and entrepreneurs at RBC Wealth Management in London. “It’s at this point that our clients come to us asking what they can do to help preserve it for the future.”
Given a lack of diversification, concentrated equity positions often have a higher level of stock-specific risk than desired. While the investment might have grown substantially in the past, there is no guarantee that this will continue in the future. Therefore, steps may need to be taken to mitigate downside risk in the event of a market downturn or a company-specific event.
“In many cases, investors with such positions will tend to have a strong grasp on company fundamentals,” says Guy Huntrods, head of investment specialists and execution at RBC Wealth Management in London. "Investors who hold onto these positions over time may experience downward price pressure from both company-specific and non-specific influences, which could derail future plans and exit strategies,” he adds. “With careful consideration and careful planning, the investor ride could be made smoother and more value could be derived from the asset."
Anyone who has a large amount of wealth invested in a single asset will likely want to consider strategies that offer protection from risks that could cause its value to fall considerably. Alternatively they may want liquidity to add diversification to the portfolio and seek to generate more returns from this position.
Stock markets are near all-time highs
Mitigating the risk of loss is important during the best of times, but it might be 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. As the post-crisis bull run enters its eighth year, many investors are beginning to wonder when it might come to an end.
Frederique Carrier, head of equities at RBC Wealth Management in London, says that, while the expectation in the near term is for modest positive returns, the current cycle will eventually start to show signs of old age, although it could be extended by some of President Donald Trump’s policies. “Business cycles tend to last seven or eight years and that is where we are right now,” Carrier says. “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 or security.”
For some people, there is a disconnect between the work that went into building a business or amassing a large asset and the work that needs to be done 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 change in regulation or a market correction?” Huntrods says. “Threats can appear unexpectedly, so it is important for people to think about what they might need to do to protect or diversify their investments and be aware of the potential strategies available to them to achieve this.”
The perils of putting all your eggs into one basket
History is replete with stories of lost fortunes, even for those who thought their wealth was relatively safe being tied up in a large, blue-chip company. Some investors might feel a sense of safety by being invested in a large company, but recent corporate failures such as Lehman Brothers, Worldcom and Nortel stand as prime examples of how even a seemingly strong firm can collapse.
While the likes of Warren Buffett and George Soros are famous for making large fortunes through concentrated investment strategies, there are far more investors out there who have bet the farm on one idea and lost everything. For business owners and entrepreneurs, as well as corporate executives, the very asset that helped them to build their wealth can also pose one of the biggest risks to their future financial security. An investment in a single company’s shares are exposed to what is known as idiosyncratic risk, which are specific factors and events that could affect the performance of that one company and, in turn, cause its share price to fall. A diversified portfolio, on the other hand, will be exposed to the risk of a stock market downturn, but will act as a cushion should any single company share price fall in value.
Sometimes it’s hard to let go
The simplest solution to a concentrated equity position is to sell some of your shares so that you can invest elsewhere. But for some people this is neither possible nor desirable, either because the securities cannot be sold until some point in the future, or because they want to retain certain privileges or arrangements, such as voting rights. For others, the reluctance to sell might be less definitive, such as an emotional attachment to the company or an expectation that the share price will rise in the future.
“People can have several reasons for not wanting to sell shares they hold in a company, whether it’s because they are emotionally attached to them or because there may be negative financial implications from doing so,” Younger says. “Our role is to find the most suitable solution for them and to guide them through that process so that they receive the best possible outcome.”
Selling an asset does not always make sense, of course. When selling everything is less desirable, several options are available. Incremental selling over a period of time is the most straightforward and works in situations where there is a desire to avoid putting downward pressure on the share price or to overcome the emotional hurdle of letting go. In situations where it is necessary to continue to hold the asset, it is possible to use hedging strategies that act as insurance against any fall in the value of a stock. Another option is to use leverage by borrowing against the portfolio and using the loan to invest in other assets.
When wealth preservation becomes the priority
Concentrated equity positions pose plenty of challenges. While they might have delivered exceptional returns in the past, there is no guarantee that they will continue to do so in the future. And considering how far stock markets have risen in the years following the financial crisis, there are rising concerns that a correction looms somewhere on the horizon. Given these risks, any person or family with a substantial amount of wealth invested in a single asset that wants to move to a phase of wealth preservation will likely seek ways to mitigate against potential losses.
Solving the problem of a concentrated equity position is not always straightforward and will need to take into account each specific circumstance. Whether it means selling down a position and diversifying into other assets, borrowing against a portfolio to fund new investment opportunities, or using hedging strategies to mitigate against potential losses, reducing concentration risk can play a vital role in protecting your wealth for now and for the future.
The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment adviser if you are in doubt about the suitability of such investments or services.
Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. This article is not an offer to sell or a solicitation of an offer to buy any securities. This article 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.