CONCENTRATED SINGLE-ASSET POSITIONS Flashcards
12.a: Explain investment risks associated with a concentrated position in a single asset and discuss the appropriateness of reducing such risks.
The risk in such assets is both systematic and company-or property-specific. In the single factor CAPM, this would be beta. Multifactor models might include unexpected changes in the business cycle or inflation as systematic risks. Nonsystematic risk increases the standard deviation of returns without additional expected return.
12.b: Describe typical objectives in managing concentrated positions.
There are three common objectives when managing a concentrated position: 1. Reduce the risk caused by the wealth concentration. 2. Generate liquidity to meet diversification or spending needs. 3. Optimize tax efficiency to maximize after-tax ending value.
12.c: Discuss tax consequences and illiquidity as considerations affecting the management of concentrated positions in publicly traded common shares, privately held businesses, and real estate.
tax liability. Illiquidity and/or high transaction
12.d: Discuss capital market and institutional constraints on an investor’s ability to reduce a concentrated position
Institutional and capital market constraints Securities law and regulations
12.e: Discuss psychological considerations that may make an investor reluctant to reduce his or her exposure to a concentrated position.
Typical cognitive biases include conservatism in maintaining existing beliefs; confirmation in seeking support for what is already believed; illusion of control when the investor believes he can control what will happen to the investment; anchoring and adjustment in making decisions in reference to the current position held; and availability in making decisions based on ease of recalling information.
12.f: Describe advisers’ use of goal-based planning in managing concentrated positions.
A goal-based decision process modifies traditional mean-variance analysis to accommodate the insights of behavioral finance theory. ( repeat from behavior finance middle section) personal risk bucket market risk bucket aspirational risk bucket
12.g: Explain uses of asset location and wealth transfers in managing concentrated positions
Sell the asset: This will trigger a tax liability and loss of control. Monetize the asset: Borrow against its value and use the loan proceeds to accomplish client objectives. Hedge the asset value: Often done using derivatives to limit downside risk.
12.h: Describe strategies for managing concentrated positions in publicly traded common shares.
Short sale against the box. Equity forward sale contract. Forward conversion with options. -selling calls and buying puts with the same strike price Total return equity swap. Prepaid variable forwards (PVF) are economically similar to a collar and loan in one transaction.
12.i: Discuss tax considerations in the choice of hedging strategy.
Index tracking with active tax management.
A completeness portfolio structures the other portfolio assets for greatest diversification benefit to complement (complete) the concentrated position.
A cross hedge
– 1. Short shares of a different auto stock or another stock that is highly correlated with the concentrated position.
- Short an index that is highly correlated with the concentrated position. Shorting a different stock or an index will introduce company-specific risk. A negative event could affect the concentrated position but have no offsetting effect on the value of the short position.
- Purchasing puts on the concentrated position is also considered a cross-hedge in that the put and stock are different types of assets.
Exchange funds
12.j: Describe strategies for managing concentrated positions in privately
held businesses
In a divestiture, sale, or disposition of non-core business assets, the owner sells
nonessential business assets and then directs the company to use the proceeds to pay
a large dividend to, or repurchase stock from, the owner.
12.k: Describe strategies for managing concentrated positions in real
estate.
Mortgage financing
A donor-advised fund or charitable trust
A sale and leaseback
