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13 concentrated single-asset positions (general principles of managing…
13 concentrated single-asset positions
overview
publicly traded single-stock positions
privately held / family-owned businesses
investment real estate
risks
systematic risk
company-specific risk:
volatility lessens the benefit of higher exp capital accumulation
diversified portfolio smaller chance of large losses
property-specific risk
general principles of managing
objectives
appropriateness of risk reduction
cash flow needs
optimize tax efficiency
client objectives and concerns → risk retention
considerations affecting
tax consequences of an outright sale - embedded tax liability - deferring
liquidity
institutional and capital market constraints
margin-lending rules / risk based
securities laws and regulations
contractual restrictions and employer mandates
capital market limitations: ability to borrow share / liquidity of the stock
psychological considerations
emotional biased
→if equivalent sum to the value received in cash
/ fundamental analysis
cognitive biases→be brought to the attention
goal-based planning
expand Markowitz framework incorporating risk buckets
personal risk bucket - protection from poverty or dramatic decrease in lifestyle
market risk bucket - high likelihood to maintain the current standard of living
aspirational risk bucket - opportunity to increase wealth substantially → allocate concentrated positions
primary capital - allocation to the personal and market risk bucket
surplus capital - allocation to aspirational risk bucket
asset location and wealth transfers
asset location - what type of account an asset is held within
wealth transfer before concentrated position appreciated greatly
estate tax freeze - early ownership transfer
→ recapitalizing
minimize transfer taxed after significant appreciation:
family limited partnership - valuation discounted
concentrated wealth decision making
1 identify and establish objectives and constraints
2 identify tools/strategies that satisfy
3 compare tax advantages and disadvantages
4 compare non-tax
5 formulate and document an overall strategy
managing the risk of concentrated single-stock positions: outright sale / monetization / hedging
key tax considerations
if internal inconsistency of tax codes
→ opportunity to reap tax saving or reduce tax risk
key non-tax considerations
counterparty credit risk - OTC derivative
ability to close out prior to expiration
price discovery
transparency of fees
flexibility of terms
minimum size constraints
strategies
equity monetization
process:
remove a large portion of the risk inherent
borrow against the hedged position
forward conversion with options
a synthetic short forward position against the asset held long
riskless / high LTV ratio
equity forward sale contract
private contract / riskless
short sale against the box
shorting a security that held long
earn money market rate of return
high loan to value (LTV) ratio
total return equity swap
series of exchanges of total return for fixed or floating
fully hedged / money market return
tax treatment
no actual transaction
lock in unrealized gains: hedging
purchase of puts:
/ lock in floor price
/ retain unlimited upside potential
/ defer capital gains tax
cashless (zero-premium) collars:
/ hedge against price decline
/ retain certain degree upside
/ defer tax
prepaid variable forwards:
combined hedge and margin loan
choosing the best - mismatch in character problem
yield enhancement
decreasing volatility by writing covered calls
retain full downside exposure
capped the upside potential
believes the stock will be stuck in a trading range
psychologically prepare the owner to dispose the shares
tax-optimized equity strategies
combine tax considerations
index-tracking with active tax management
construction of completeness portfolios
*come with certain risks and costs:
intended implemented over time
tax when liquidated
cross hedging
hedge market and industry risk
but retains all company-specific risk
using derivatives on a substitute asset with expected high correlation
exchange funds
an investment fund structured as a partnership
managing the risk of private business equity
owner often asset rich but cash poor
highly appreciated and trigger significant tax
result in loss of control or dilution of ownership stake
monetization strategies
staged or phased over time to generate liquidity
sale to strategic buyers
take a long-term view
executing add-on or fill-in acquisitions
sale to financial buyers- PE firms
leveraged recapitalization - company's balance sheet
transfer a portion of stock for cash
retain minority ownership interest in the freshly capitalized entity
typically taxed currently
staged exit atrategy
sale to management or key employees - management buyout (MBO)
promissory note deferred and contingent on financial performance of the company
divestiture - sale or disposition of non-core assets
sale or gift to family member or next generation
personal line of credit secured by company shares
arranging a personal loan
initial public offering (IPO)
the cost are significant
financing tool used to take company grow to new level
remain actively involved in the company
employee stock ownership plan (ESOP)
considerations
astute transactional tax panning and structuring
how much is paid up front in cash
how much is deferred or contingent
managing the risk of investment real estate
attractiveness factors
current valuation
tax rate
condition of credit markets and lending conditions
level of interest rates
monetization strategies
mortgage financing
without trigger a tax
cash flow neutral LTV ration:
net rental income = fixed mortgage payment
structure as non-recourse loan
charitably inclined
donor-advised fund (DAF)
tax-exempt charitable trust
sale and leaseback
raise capital of free up the owner's equity for other uses
while retaining the use of the facility
trigger a tax
rental deductibility for tax purposes
debt associated removed from the balance sheet
JV / condominium structures / long-term ground lease / exchange
monetize
: something is to access its cash value without transferring ownership