The Concentration Conversation

Transcript

Hi, I’m Brian Smith, co-head of the Eaton Vance Wealth Strategies Group. In this video, we will discuss the concentration conversation.

Many investors hold a single stock that makes up a disproportionate share of their wealth, often due to incentive compensation, inheritance, or an investment that has outperformed. While these concentrations are often a sign of your clients’ success and may very well be a significant source of their wealth, the reality is most individual stocks underperform broad market indices over time. Concentrated positions can increase risk and introduce significant volatility, they also frequently come with tax implications, and potential emotional friction.
Advisors play a critical role in helping clients understand and manage these risks. Diversification isn’t simply a financial decision; it’s a behavioral one as clients often face common biases such as overconfidence, loyalty to the company, anchoring to a prior price, or fear of tax consequences. Navigating the concentration conversation with clients requires both technical planning and thoughtful coaching.
To help guide these conversations, Eaton Vance developed the HOPES framework, incorporating multiple solutions to address concentration risk. HOPES is an acronym which stands for:
• Hold
• Options and Derivatives
• Planned Giving
• Exchange Funds
• Strategic Selling

These five strategies can be deployed individually, yet a better way of approaching this framework is to think about each letter as a bucket we are filling up to address and align with different client goals.
Let’s explore each one further.
• Hold: This is the first bucket a client needs to define. We need to establish how much of a concentrated stock, if any, a client wants to maintain ownership of. You are helping clients determine a prudent hold target and how the position may impact risk and long-term financial goals.

Let move on to:

• Options and Derivatives: Clients can use various overlay strategies, such as selling calls, buying puts, collaring or using variable prepaid forwards. These strategies can help modify the risk profile of the concentration, generate income, or help monetize the position. In some cases, the monetization offered through a variable pre-paid forward can be used for diversification or tax-loss harvesting strategies.

Up next is:

• Planned Giving: With planned giving, there are a few conversations to be had:

• First is the funding source. By funding philanthropic initiatives with concentrated stock, clients avoid capital gain recognition and keep cash on hand.
• The second is the type of charitable giving vehicle: whether that is direct giving or through a split interest vehicle.
• Finally, when to give – Donor-advised funds and family foundations allow clients to combine, or “bunch”, future gifts to maximize their current year deduction and centralize giving. Pooled income funds and Charitable Remainder Trusts may provide an up-front tax deduction and supplement future income needs.

The itemized deduction created through philanthropy may allow for a capital gains budget that could complement your sell strategy which we’ll get to momentarily.

Pivoting to:

• Exchange Funds: For qualified clients, Exchange Funds and other limited partnerships utilizing long/short investment techniques may offer a path to diversification without triggering a taxable event. These funds are often funded with a client’s most appreciated tax lots. Because we are deferring the client’s largest gain, they’re benefiting from the power of compounding on that tax deferral. This may make exchange funds a great fit for longer-term investment goals or estate planning.

Last up is:

• Strategic Selling: This is the process of prioritizing specific tax lots when selling to minimize the upfront tax consequences. It also opens the door to discuss staged diversification. Selling doesn’t need to be a rip the band-aid off exercise, it can be selling over multiple tax years to spread out the tax friction over time.

When you are having a conversation about selling, you are really having a conversation about asset allocation. How will the after-tax proceeds be redeployed once the stock is sold? This is a perfect time to educate clients on how incorporating systematic tax loss harvesting into their asset allocation can create an offset for capital gain realization. This is often accomplished through direct indexing.

Think of the HOPES framework as diversification of your diversification strategy.

There is no silver bullet or single solution to address the complex planning objectives of high-net-worth clients. Transform client conversations from piecemeal solutions to the HOPES framework, and provide clients a blueprint for balancing conviction, risk and investment goals.