PORTFOLIO ASSET ALLOCATION STRATEGY:
AN ULTIMATE GUIDE FOR CORPORATE EXECUTIVES

When we first meet with a client, we start by simply having a conversation to get to know them and learn about their goals. It may seem basic, but doing this actually helps us uncover the client’s initial financial planning needs.

Sometimes, these needs are among the most important issues that need addressing. For example, we recently met with a new client, and through our conversation about his profession and career, discovered that he held a high concentration of stock. This prompted us to pursue an asset allocation strategy first and foremost to reduce risk in his investment portfolio.

American business author, Michael LeBoeuf, once said, “The most important key to successful investing can be summed up in just two words—asset allocation.” As a financial advising team who works with many top-level executives with highly concentrated positions in their portfolios, we couldn’t agree more. A solid asset allocation strategy is foundational to your overall financial plan, and it’s of particular importance for corporate executives.

The balance of these asset classes will depend on several factors, including your age, risk tolerance, investment goals, and time frame. For example:

• If you are at the age where retirement is just around the corner, you should consider minimizing your exposure to stock to lessen the impact of potential negative market conditions on your portfolio.
• However, if you are nearing retirement age, but you know that you want to work longer than the average executive and you have a higher risk tolerance, you could consider keeping a more stock-heavy asset allocation.
• If your investment goals for your portfolio are to generate wealth, and you have other assets to help with capital preservation, then a stock-heavy asset allocation might also be fitting in this example.
• Lastly, if you have a long time frame before you need to access the funds for income or other purchasing purposes, then you might be able to take on more risk and a higher equity-based asset allocation than someone who needs to generate income from their investments within the next five to 10 years.

Asset allocation is an important strategy for all investors to be aware of because becoming overly weighted in a particular asset class or investment sector can increase risk in anyone’s portfolio. When executives are being offered employee stock options, this tends to compound the concentration problem. If it goes unaddressed, it could have serious ramifications. For example, if an executive had a large stock concentration heading into 2008 and was nearing retirement, a 40%+ loss could have decimated their retirement savings.

Read more about the Carpenter Team’s process for implementing an asset allocation management plan for its executive clients.

There is no definitive winner when it comes to either strategy; there are positives and negatives to each. Just like nearly any other strategy in the financial world, it depends on your unique needs and goals to determine which is best for you.

A passive fund, one that reflects the S&P 500, for example, is an investment fund that is not actively traded and therefore typically offers a low-fee option for investors. The fund itself will reflect the particular index that it follows, and you can expect to see similar performance. This is a good strategy if you are looking to invest in a particular index and keep your costs as low as possible. On the flip side, a passive fund does not offer active trading, which could result in missing out on a particular market upswing identified by an active fund manager.

If you would like your fund to employ a particular quantitative or qualitative investment strategy that goes outside of a particular index to seek larger returns, then an actively traded fund might be a good fit for you. Due to the nature of an actively traded fund, it will typically incur more fees and therefore be more expensive to own. This is a trade-off and one of the biggest cons to consider before investing money with an active fund manager. These additional fees account for the active management and day-to-day trading that you pay for when seeking higher-than-index returns.

As financial advisors who have served executive clients for decades, we have identified three main strategies that can be of particular benefit when attempting to diversify that concentrated position.

Exchange funds

An exchange fund is accomplished with the help of a trusted financial advisor, who either partners with an established exchange fund or helps you develop one with other executives. An exchange fund accepts large concentrated stock positions in exchange for shares of the fund itself. The shares that you receive in return for your concentrated position are diversified due to the other investors who have added their concentrated positions to the fund as well.

You would receive enough shares to equal the current market value of your concentrated stock position. For example, if you owned $5 million worth of XYZ stock, you might consider an exchange fund to help allocate your assets across $5 million worth of 20 different stocks within the exchange fund.

Sell-off strategy

A basic sell-off strategy is typically derived between the executive and their financial advisor in an attempt to sell employee-owned stock at certain predetermined points of price fluctuation or on predetermined dates to achieve asset allocation and greater portfolio balance. Many times, though, a sell-off strategy will also include an advisor’s discretion in identifying certain times when it makes sense to sell for a particular reason.

A general sell-off strategy offers the flexibility to make decisions on how and when the concentrated stock position is sold. This is usually achieved over a longer period of time, sometimes exceeding a year, depending on the market conditions. For example, you might work with your advisor to sell 50% of your company stock holdings over the next three years, spreading out your capital gains tax over those years.

Index proxy

An index proxy strategy is a software-based approach to diversifying your concentrated stock position. An index proxy will sell off a certain number of shares when a particular set of market conditions apply. An index proxy strategy will account for tax liability as a result of the sale of low-basis stock. It will also account for large capital gains that are a by-product of selling appreciated stock. The formula that is developed by an experienced executive financial planner will reflect your investment goals and objectives.

This can sometimes lead to a long sell-off period, even lasting multiple years, but it is a completely quantitative approach to diversifying your concentrated stock position. It is, however, imperative to work with a seasoned financial advisor when implementing this method. For example, you might find that the boundaries you have set in your formula are too strict and are causing your stock to be sold too slowly. Or, the opposite could happen where you are unloading stock too quickly and racking up a large tax bill. An advisor with experience in this strategy can help you make changes along the way.

Do these asset allocation strategies have a place in your financial plan? Meet with Wade Carpenter and team to ensure you’re putting the right methods to work.

For example, your only equity holding could be your own employer’s stock and the rest of your portfolio could contain other asset classes, such as bonds or commodities, to offer market downturn protection.

Your concentrated position could certainly pay off for you as well, especially if you happen to work for an up-and-coming company that could potentially double its share price. If that happens and you hold a large amount of stock, you would feel the benefits of that as well.

Your advisor should not discount your employer stock position, but rather incorporate it into your overall asset allocation strategy and equity compensation plan. This will ensure you maintain good standing with your company as well as personal financial protection for you.

When you work and plan with someone who has guided countless executives to successful financial milestones, you greatly increase your odds of success. We all want to be sure we are doing the right things to build toward a better future for ourselves and our families. Choosing to work with the right financial advisor is one big step in that direction.