What strategies are available for managing concentrated stock positions?

Concentrated stock positions are a major risk for private wealth clients, often arising from IPOs, stock options, or inherited shares. CFA Level III tests several strategies for managing this risk, each with different tax, control, and liquidity implications.

Strategy 1: Outright Sale

Simply sell the stock and diversify. Most straightforward but triggers full capital gains tax.

• Tax impact: Immediate capital gains realization
• Best for: Low-cost-basis positions when tax rate is acceptable, or positions with losses

Strategy 2: Exchange Fund (Swap Fund)

Pool concentrated positions from multiple investors into a diversified fund. Each investor swaps their single stock for shares of the diversified fund.

• Tax impact: Tax-deferred (no sale occurs)
• Limitation: 7-year lock-up; SEC rules require 20% illiquid assets in the fund

Strategy 3: Equity Collar (Protective Put + Covered Call)

Buy an OTM put to protect downside and sell an OTM call to finance the put. This creates a price range within which the stock can fluctuate.

• Tax impact: No immediate gain; constructive sale rules may apply if collar is too tight
• Best for: Retaining some upside while hedging catastrophic loss

Strategy 4: Prepaid Variable Forward

Agree to deliver shares at a future date in exchange for an upfront cash payment. The delivery amount depends on the stock price at settlement.

• Tax impact: Deferred until delivery date
• Best for: Immediate liquidity need while deferring taxes

Strategy 5: Charitable Strategies

Donate appreciated shares to a charitable remainder trust (CRT) or donor-advised fund. Avoid capital gains and receive a tax deduction.

• Best for: Philanthropically inclined clients

Example: Thornwell Family Office manages $15M for Rebecca Thornwell, who holds $9M (60% of NW) in Aldrin Technologies stock with a cost basis of $1.2M. The embedded gain is $7.8M. An outright sale at 23.8% LTCG rate would cost $1.86M in taxes. Instead, the advisor recommends:

• $3M via a prepaid variable forward for immediate liquidity
• $2M donated to a CRT for philanthropic goals and income stream
• $4M collared with a 15% OTM put and 25% OTM call to retain upside while hedging

For the CFA Level III exam, be prepared to recommend and justify the appropriate strategy based on the client's tax situation, liquidity needs, and risk tolerance. Explore our CFA III practice materials for scenario-based questions.