Managing The Risks And Opportunities Of Stock Concentration

Managing The Risks And Opportunities Of Stock Concentration

March 15, 2016

by Tim Kochis

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Excerpted with permission of the publisher, Wiley, from Managing Concentrated Stock Wealth, Second Edition: An Advisor’s Guide to Building Customized Solutions by Tim Kochis with Michael J. Lewis. Copyright © 2016 by Tim Kochis. All rights reserved. This book is available at all bookstores and online booksellers, as well as from the link on this page.

Stock concentration is among the most familiar issues financial advisors face – and one of the oldest. They long predate the booms and busts that threatened so many portfolios in the past 20 years – and may do so again. They’re likely to remain part of the job of managing wealth as long as entrepreneurs create new wealth and as long as stock, options, and other stock-based measures are part of executive compensation. In the 10 years since the first edition of Managing Concentrated Stock Wealth, many more options have been granted and, even more so, restricted stock and/or stock units have become heavy components of overall executive compensation. The very large grants of options made in the depths of the global financial crisis of 2008 and early 2009, to take advantage of much depressed stock prices, have since grown greatly in value and are now reaching the later years of their 10-year terms. Based on median grant data from S&P 1500 companies, presented by Equilar’s[1] 2012 report on executive compensation, options for more than 1.3 billion company shares were granted in 2009 . . . at 2009 prices! For 2013, Equilar reports that the value of other stock-based compensation (restricted stock and performance shares) was nearly 22 times greater than the value of the 2013 options grants for S&P 1500 CEOs. And these data only represent the 1500 largest U.S. companies. No reliable data exists for what has occurred in the thousands of smaller companies, but a reasonable guess is that the potential wealth creation – and concentration – in publicly traded stock, overall, has been vast.

It’s fair to say that almost every investor is aware of concentration as an important investment issue and that every financial advisor recognizes the need to be able to respond to the concerns investors have about it. Virtually every book on investing describes the risks of concentrated wealth and identifies at least a few techniques for dealing with it – as a problem. Very few treat concentration as a potential opportunity.

The wealth-building opportunities today are even greater than 10 years ago; the risks remain; but some of the tools to manage those risks are even sharper today. This Second Edition sets out more than 40 years’ experience with thousands of clients, most of whom have had some form of stock holding that others, at least, would call concentrated.

The most straightforward solutions are introduced first, followed sequentially by others, each increasingly complex. That path has two purposes. First, it allows us to more thoroughly address the cumulative nature of the more complex strategies. Deploying a costless collar, for example, presumes a considerable degree of understanding of the more fundamental techniques. The second purpose is to lay out a pattern of choices to consider for the client. If the client’s problem can be solved with one of the simpler approaches, there may be no reason to go further. This triage is valuable even if you expect that the optimal strategy for a particular client situation is far along the scale of complexity. Clients often surprise us. Once exposed to a simple course of action, they often abandon what we thought was their taste for something more elaborate, and, once exposed to the costs and risks of those more elaborate strategies, they often want to go back to something more tame. Nothing about that trait of human nature has changed in the past 10 years.

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Stock concentration