WHEN SELLING OR GIVING ISN’T ENOUGH
Reducing the risk in a client’s concentrated portfolio can go beyond selling shares or donating them to charity. In selected situations, other methods may be useful: Exchange funds. The client contributes shares from the concentrated position in return for a portion of a diversified stock portfolio. “We have recommended exchange funds in cases when a client didn’t have a charitable intent, wanted to diversify, but didn’t want to incur taxes now,” says Adam Fuller of Homrich Berg in Atlanta. “After being in the fund for seven years, this client receives a proportional distribution of the stocks in the fund.”
The key is how well the shares in the fund perform. “Stocks that sounded good seven years ago, when the exchange fund was built, might not be so good today,” Fuller says.
Protective option collars. The client purchases a put option on the stock in the concentrated position, limiting the downside risk, and sells a call option to help fund the hedge. “This strategy is generally more effective for shorter periods of time,” says Lucas Bucl at KHC Wealth Management in Overland Park, Kansas, “rather than a permanent risk management strategy.”
Prepaid variable share forwards. The client enters into a contract to sell a variable number of shares in the future in exchange for cash now, typically 70% to 90% of the current value. “This diversification strategy defers taxes and establishes a floor (and ceiling) on the stock price,” Fuller says. “We have not had a client establish a variable forward in a number of years due to the high cost and uncertainty over tax regulations.” The investment minimums for such strategies may be $500,000 and up, Fuller says.