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Despite the market turmoil over the past several months, and the corresponding dramatic fall in the price of many stocks, concentrated, low basis stock positions continue to constitute a significant percentage of the net worth of many investors and families.

Investors seeking either to protect the value of their stock without selling it or, conversely, sell or gift it in a tax-effective way, have several financial and charitable strategies at their disposal.

Financial Strategies

• Completion Strategies: The stock can be sold in a disciplined and tax-effective manner. The concept behind completion strategies is simple – sell out of the stock in an orderly manner and reinvest the after-tax proceeds in a portfolio that is as uncorrelated as possible to the remaining concentrated stock. For example, if an investor holds a concentrated position in a bank stock, the reinvestment proceeds should go into strategies and asset classes that are as uncorrelated as possible to the financial services sector. The purpose is to reduce as much as possible the unsystematic risk associated with the concentrated stock position. Investors can also improve the tax-effectiveness of this strategy by reinvesting some of the sales proceeds into tax-enhanced index strategies, and use the tax loss harvesting associated with these strategies to offset the taxes realized as the underlying stock is sold.
• Hedging Strategies: These are options-based strategies whereby the investor purchases a put option for protection and partially or fully pays for this by selling a call option. This protected position can then be borrowed against, with the proceeds redeployed in a more diversified portfolio. The primary vehicles utilized are Equity Collars and Variable Prepaid Forwards (VPF). There are differences between these two structures, especially in how much liquidity can be generated from each (the amount is usually higher with a VPF if the intent is to reinvest in marginable securities), but the underlying premise is the same – protect the value of the stock at or near today’s market price, and then borrow against the position to effectively “monetize” the position without selling it for tax purposes. Executed properly, the investor will defer taxes on the sale of the stock until the maturity of the collar or VPF.
• Exchange Funds: Under these strategies, investors contribute their concentrated stock position to a larger, more diversified pool of stocks (that come from other investors doing the same thing), and receive in exchange a pro rata position in the larger pool. Executed properly, the result is that the investor has improved his/her overall diversification without triggering a tax event.

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