It's an article of faith in the wealth management world that there are no cookie-cutter solutions for the affluent.

Of course all clients, even those without high-net-worth money, are unique. But wealthy clients, because their needs are so complex, somehow manage to be more so. From taxes to inheritances and everything in between, the rich require solutions that are tailored to their specific needs, and the consequences of failing to tailor appropriately are dire.

Given all this, it's more than a little surprising that financial advisors have proven uninspired when managing the concentrated stock positions of their wealthiest clients.

It's Written in the Numbers

Earlier this year, we recapped the results of our survey of the financial status and concerns of 388 senior executives with concentrated stock holdings. Each respondent was a VP or higher in a publicly traded, Fortune 1000 company. They were divided into three groups: those with $500,000 to $1 million in investable assets (191 of the 388 respondents); those with $1 million to $5 million in investable assets (126); and those with $5 million or more (71).

We found that the group as a whole had 43.4 percent of its investable assets tied up in company stock. For members of the wealthiest segment, the percentage was much higher — 62.2.

As a direct result of this concentration, the executives were poorly diversified and, depending on how much their stock had appreciated, they could be tactically illiquid because of the tax consequences of cashing it in.

That lack of diversification and liquidity explained two of the executives' key financial concerns: the fear that the price of the company stock would go down (cited by 88.7 percent of the respondents) and the concern that they weren't properly diversified (cited by 37.6 percent). It should be noted that among the wealthiest group, diversification concerns were top-of-mind: 71.8 percent said they worried about it.

Clearly, then, the financial advisors to this group are not tailoring as well as they should be. The question this begs is why so many advisors seem comfortable having their clients heavily concentrated in company stock.

The Advisor Point of View

As part of an effort to answer this question, we administered a second survey — this time looking for advisors' take on concentrated stock holdings. Of the 618 financial advisors we surveyed, 35.5 percent or 219 were independents, 34.1 percent or 211 worked in wirehouses, and the remaining 30.4 percent or 188 worked for regional financial services firms. We asked them what strategies, techniques or products they would recommend to a client with a large, concentrated stock position who was anxious because the stock constituted the lion's share of his wealth. It was an open-ended question (the advisors were not given a list of answers to choose from).

The result was a list of seven answers with “sell” and “borrow” leading the pack. With one minor exception (“tax shelters,” which are illegal), the advisors all cited viable options, depending on the client's specific financial situation and goals.

But surprisingly few cited “private annuities,” which under the right circumstances could be as workable an option as selling or borrowing.

Some of the advisor opinions lined up along company lines. Wirehouse advisors were far more familiar with “exchange funds,” for example, and independents knew more about “charitable instruments.”

Still, it was clear the group as a whole was not aware of all of the options available to them and to their clients.

The List

Let's have a look at some of the more important responses and try to pinpoint situations in which they might be good solutions to a stock concentration problem.

Selling stock in a block or over time might work for those clients whose shares had not appreciated dramatically, or for those who had a capital loss to offset. But for those with highly appreciated stock and no losses, it would result in substantial capital gains and the associated taxes.

Borrowing would work best for those who wanted to hold on to the stock but needed money to build a more diversified portfolio.

Hedging offers a number of ways to guard against the stock price falling or to lock in gains, including prepaid forwards, cashless collars and puts.

Exchange funds allow the stockholder to trade his or her stock to a commonly held fund, essentially a mutual fund for concentrated stock, in exchange for shares. They could later sell shares in the fund rather than the stock itself, minimizing taxes.

Charitable instruments, such as charitable remainder trusts, charitable lead trusts, private foundations and supporting organizations, are an option for those clients who are looking to give something back — to someone other than the government. With a charitable remainder trust, for example, the beneficiaries get a steady income stream from the contribution of charitable stock, and whatever is left after the payment provision expires — the remainder — goes to charity. In a charitable lead trust, the charity gets the income stream for a fixed period, after which the remainder goes to the beneficiaries. Both options can minimize or eliminate certain taxes.

Private annuity is an approach grounded in estate planning. The stock is given by its owner to a second party (typically a family member) who sells it tax-free and pays the former owner over the course of his or her lifetime, spreading out the tax bite. Should the donor die before the payback has been completed, the second party keeps the remainder of the money without further tax consequences.

Tax shelters for the purposes of this article are illegal, as noted above.

Get Informed

The moral of the story is that in order to best serve clients (especially affluent clients, such as corporate executives), financial advisors need to be aware of every option. Financial circumstances — a client's age, charitable leanings, estate considerations, to name but a few — can add up in very different ways. Knowing every detail about each option would be a full-time job in itself, but advisors should at the very least learn the basics of each approach to managing concentrated stock positions. Such knowledge is readily available through training programs offered or subsidized by most securities firms (or through seminars for independent brokers).

Even for those who plan to specialize in a single approach, such education is advisable, if for no other reason then to look well-informed in front of an important client.

Ideally, though, such education leads to the promised land: a place where wealthy clients get intelligent advice on the various ways in which a highly concentrated stock position might be diversified.

Writers' BIOS:
Russ Alan Prince
is president of Prince & Associates.

Hannah Shaw Grove is managing director at Merrill Lynch Investment Managers.

A Game of Concentration

Strategies cited by financial advisors for breaking up concentrated stock positions.
Strategies Wirehouse FAs Regional FAs Independent FAs Total
Sell 99.1% 93.6% 88.6% 93.7%
Borrow 93.4 85.6 72.6 83.7
Hedge 68.2 54.3 36.5 52.8
Exchange fund 62.6 60.1 32.4 51.1
Charitable Instruments 43.1 39.4 47.5 43.5
Private Annuity 0.9 0.0 0.5 0.5
Tax shelter 0.0 0.0 1.4 0.5
N = 618 financial advisors.
Source: Prince & Associates, 2003.