Concentrated Single-Asset Portfolios

Question 1

What risks do single concentrated positions hold?

Answer 1

1. Systematic risk - market risk
2. Company specific risk
3. Property specific risk

Question 2

What are the typical objectives in dealing with concentrated positions?1

Answer 2

1. Reduce the risk
2. Generate liquidity
3. Optimize taxes

Question 3

What issues often arise with managing risk for concentrated public equity positions?

Answer 3

1. You must hold it

2. You want voting control

Question 4

What issues often arise with managing risk for concentrated private equity positions?

Answer 4

1. Too early to sell
2. Want to keep the business in the family
3. Wish to maintain control

Question 5

What is the difference between rules based vs risk based margin lending?

Answer 5

Rules based will have specific limits, risk is known as portfolio margining and is more flexible

Question 6

What are some typical contractual restrictions and employer mandates that make hedging single asset positions hard?

Answer 6

1. IPO lock up periods
2. Blackout periods
3. Right of first refusal for private shares
4. Tag-along/drag along for private sales

Question 7

What are some typical capital market limitations to hedging positions?

Answer 7

1. Ability to short

2. Liquidity of shares

Question 8

What are the common emotional biases that make people reluctant to hedge positions?

Answer 8

Emotional
1. Overconfidence/familiarity gives illusion of control
2. Status quo bias
3. Endowment effects
4. Loyalty
Cognitive
1. Conservatism
2. Confirmation bias
3. Illusion of control
4. Anchoring and adjustment
5. Availability

Question 9

What are the three risk “buckets” referenced in goals based planning?

Answer 9

1. Personal risk - very low risk, protect from destruction
2. Market risk - maintain or increase current standard of living
3. Aspiration - increase wealth substantially, big risk

Question 10

How do we determine whether we need to monetize a concentrated position?

Answer 10

1. What are our spending wants and needs? then determine
2. What is the PV of our needs?
3. Do our primary assets support this?
   If you need more money, you need to monetize

Question 11

What are some options for transferring wealth before the asset appreciates greatly?

Answer 11

1. Direct gifts to family or to trusts

2. Estate freezes

Question 12

What are some options for transferring wealth after the asset appreciates greatly?

Answer 12

1. Contribute to a family trust/partnership

Question 13

What are the three basic techniques to control public equity risk?

Answer 13

1. Outright sale
2. Monetize (loan)
3. Hedging

Question 14

What are the basic non-tax considerations for hedging concentrated positions using derivatives?

Answer 14

1. countryparty risk for OTC
2. Price discovery
3. Fees
4. Size

Question 15

What are the basic steps in an equity monetization strategy?

Answer 15

1. Remove risk
2. Borrow against
   The premise is that you are creating a riskless position that earns risk free rate and borrow against it.

Question 16

What is a short sale against the box and why would you use it?

Answer 16

A short sale against the box is when you short an equal/partial amount of shares.
You would do this for simplicity and because it is the least expensive.
However, you are not allowed to be long and short the same security in many countries (Canada)
This biggest risk is a massive drop and you can’t actually give your shares if they are called.

Question 17

How do you use total return swaps to hedge single positions?

Answer 17

Very simple - swap returns, then borrow against the hedged position

Question 18

How do you use a synthetic forward conversion to hedge single positions?

Answer 18

You could create a synthetic short using options, then hedge against

Question 19

What tax considerations should we have when we are considering our equity monetization strategy?

Answer 19

1. How are gains and losses on the hedge treated?
2. How is the hedge settled?
3. What is the interest on the loan?
4. Does the hedge effect taxation of dividends?

Question 20

What are some of the basic hedging strategies?

Answer 20

1. Purchase puts (preferably long dated)
2. Cashless collars
3. Pre-paid variable forward

Question 21

Explain how a pre-paid variable forward works

Answer 21

1. Create a normal collar + you will get a margin loan in the same instrument
2. You have to agree to sell at a specific point in time, but a dealer will pre-pay you for them
   Assuming the collar had a put at $95 and a call at $110…
   If you’re below the put, you deliver all shares
   If youre between the money, you deliver the base number of shares
   If the call is ITM, you will deliver the base shares + the value of the shares above the strike on the call

Question 22

Why would you prefer OTC options vs exchange traded for hedging?

Answer 22

Taxation - you could create one single instrument rather than creating tax characteristic mismatches

Question 23

Why would you prefer exchange traded vs OTC for hedging?

Answer 23

OTC has counterparty, transparency risk