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Seed weekly - Portfolio Concentration

Investors holding very concentrated investment portfolios are a common occurrence in the investment world. Typical examples of concentrated portfolios include where an investor has the majority of his/her wealth tied up in shares of a privately owned business, holding large amounts of your employer’s stock, or being heavily invested in certain sectors of the market.

If the wealth of an investor is tied up in a concentrated portfolio, the risks faced are markedly different from a client with a diversified portfolio. Some (but not all) of the risks faced are highlighted below:

Valuation:
The value of any asset in the shorter term, especially shares, is worth what the next person is willing to pay for it. The audited statements may point to the longer term value of a business, but a large portion of the value may be lost when the person running the business is no longer there. It is therefore important to be aware of the value of the business principle/founder in a smaller enterprise and what the business is worth if he/she is no longer there.

Liquidity:
Another big risk facing the investor surrounds the liquidity of the asset. If a person holds a large amount of a single company’s stock and needs the assets to retire with, either the capital or dividends will need to fund the income for the investor. If these shares can be easily sold and the act of selling the shares doesn’t adversely affect the price, the risk is largely mitigated. However, in many instances the shares are illiquid, not enabling the investor to generate the required cash flow from selling the shares.

Volatility:
A very serious consideration, often overlooked, is the volatility one is exposed to when your wealth is concentrated. This is often more serious when the business is very dependent on the business cycle to make a profit. More concentrated portfolios afford less protection to investors during times when the assets underperform. As a rule of thumb, the peaks and troughs of the cycles are much less pronounced in a diversified portfolio compared to a concentrated one. For long term investors this is not as much of a concern as for a person looking to sell shares in the near to medium term.

Going concern:
This risk can be applied broadly and is applicable to many different situations. The most obvious going concern risk is when you have a large holding in your own business/employer’s shares and the company goes under. If this happens you are out of a job and made a big loss financially. This is the most extreme example. It can also happen when you are employed in a certain sector and use your expertise of this sector to buy shares in a related company because of your greater understanding of the industry. Once again if the sector is going through a difficult period your employment may be at risk at the same time as when the value your investment holdings will be, often severely, depressed.

Tax:
Most business owners are subject to being taxed at a very high level when they sell their shares. The risk for them is more pronounced as the majority of the stock they own was accumulated at a very low base cost (assuming that the shares were issued when the business was founded) and therefore almost the entire value will be seen as a taxable gain by the authorities. Not planning for the effect taxation has on your investment holdings may be detrimental to your financial health.

The above are a few of the risks faced by clients with concentrated portfolios. For each of the risks faced there are a multitude of options available for an investor. At Seed we are aware of the above and many more risk factors and through expert consultation are able unlock value and mitigate risks faced by our clients. Although it is crucial to manage the risks you face throughout the year it offers peace of mind to know that you have measures in place for the new calendar year fast approaching. By setting up a consultation with Seed we are able to assist you by putting measures in place to protect your wealth against risks such as those mentioned in this article.

Kind regards,

Stefan Keeve

www.seedinvestments.co.za
info@seedinvestments.co.za
021 914 4966

Tue, 09 Dec 2014- 11:27



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