Reduce concentrated stock risk with tax-aware strategies

Key takeaways

• Concentrated stock positions create significant risks for many high-net-worth clients and potential opportunities for advisors to deliver tailored, outcome-oriented solutions.
• Different client priorities around risk reduction and tax management call for distinct strategies for diversifying concentrated positions.¹
• Long/short and options-based overlay strategies offer customizable paths to help reduce concentration risk while managing the tax impact for your clients.

Concentrated stock: a large-scale risk for clients and opportunity for advisors

More than $1 trillion of high-net-worth client assets are tied up in concentrated stock positions,² often resulting from outsized performance of a stock investment, inheritance or equity compensation from years of employment or the sale of a business.

The risk is significant, yet many clients are reluctant to reduce concentrated holdings for various reasons: they don’t want to pay the capital gains tax , the stock represents their family’s legacy, or they believe the stock will continue to rise in value.

As an advisor, you know that past outperformance does not guarantee future success. If your clients need convincing, consider sharing some context: 43% of stocks in the Russell 3000 Index since 1987 declined by more than 50% and never recovered.³

You can deepen your value and your clients’ trust by having candid conversations about the risk of holding concentrated positions and offering tax-managed diversification strategies tailored to their needs.

Choose the strategy that aligns with your client’s priorities

There is more than one way to diversify a concentrated stock position. Choose the strategy that best suits the amount and speed of risk reduction your client desires and aligns with the objectives of their portfolio. Clarify your client’s priorities by asking these questions:

‘How much single-stock risk do you want to reduce?’
‘Where would you invest the proceeds if taxes weren’t a concern?’
‘How quickly do you want to diversify the concentrated position?’

Your client’s responses will guide you to one of two strategies offered by BlackRock, which we’ll illustrate through two hypothetical clients, Michael and Charlotte. Both worked many years at Apple and have accumulated $10 million of low-cost-basis company stock, which now represents a highly concentrated share of their wealth. While both want to diversify this position without triggering a substantial tax bill, they differ in how they prioritize these competing objectives.

Use long/short strategies for tax-neutral diversification over time

Michael wishes to moderately reduce the risk of his concentrated position into a broader equity index and is comfortable taking a phased approach. However, his primary concern is the tax impact of selling his highly appreciated shares.

A long/short strategy can offer Michael a tax-neutral path to diversification. By shorting stocks that behave similarly to the concentrated stock and buying stocks that do not, you create the potential to generate tax losses that can offset gains from selling shares of the concentrated stock. Over time, the portfolio’s equity allocation becomes more diversified as the concentrated stock is gradually divested in exchange for broad equity index exposure.

Patience can be rewarding: a long/short strategy has the potential to reduce Michael’s $10 million Apple position to market weight in six years without incurring any tax liability.⁴ An experienced provider of tax-managed strategies can help you implement customized long/short separately managed accounts (SMAs) in your high-net-worth client portfolios.

Use option overlays for immediate diversification and risk reduction

Charlotte is a more risk-averse investor. She wants a speedy and significant reduction of her concentrated stock risk in favor of a more balanced portfolio.

An option overlay strategy can provide a more immediate solution for concentrated risk while helping you manage tax costs. As an example, using options strategies to synthetically swap 70% of the risk on Charlotte’s Apple position for broad market risk immediately adds diversification to her portfolio without selling any shares. The premiums earned or losses realized on the option transactions can help offset capital gains realized as you divest her Apple shares over time.

This approach prioritizes immediate risk reduction but also may create significant tax savings over selling the shares outright. Charlotte would have paid $1.6 million in capital gains taxes to achieve the same level of risk reduction from selling Apple shares.⁵

Options-based strategies offer an immediate path to diversification without sacrificing tax management. An experienced options manager can help you tailor strategies for your client’s existing portfolio and risk tolerance.

Position yourself as a strategic partner in concentrated stock decisions

Guiding high-net-worth clients through the implications of holding concentrated stock and the tradeoffs of a patient long/short approach or a more immediate options-based strategy can position you as a strategic partner who delivers tailored, outcome-oriented solutions.

BlackRock can help you manage concentrated stock risk with customized tax-aware strategies. Schedule a meeting with an SMA specialist, contact your BlackRock representative or explore our online concentrated stock resources.