Model Portfolio & SMA Strategists Showcase - Flipbook - Page 36
SMAs & MODEL PORTFOLIOS
This decision typically has to be made
years before the concentrated-position
problem this chapter addresses ever
materializes, which is exactly why
it’s worth an advisor asking a client
with significant equity compensation
about their election history early in
the relationship, not waiting until the
position has already grown large
enough to need a transition plan.
Portfolio Transitions
A
client rarely arrives with a
blank slate. More often, an
advisor inherits an existing
portfolio, sometimes well-constructed,
sometimes not, frequently carrying
embedded gains that make wholesale
replacement expensive. This chapter
covers how to move a client from an
existing portfolio into a new model,
SMA, or direct-indexed strategy
without the tax bill undermining the
whole point of the move.
WHY THIS IS ITS OWN
DISCIPLINE, NOT JUST AN
IMPLEMENTATION DETAIL
The naive approach, selling everything
and buying the new target allocation,
is almost always the wrong one for a
taxable account with any meaningful
embedded gains. Fully liquidating
a portfolio to fund a new strategy
can generate a substantial, entirely
avoidable tax bill in the same year,
working directly against the taxefficiency goal that likely motivated the
switch to a managed account in the
first place.
WHERE THE CONCENTRATED
POSITION CAME FROM
This chapter has treated the
concentrated position as a given
fact, a large, low-basis holding that
now needs careful handling. It’s
worth backing up one step, because
how that position originated often
determines what planning options are
actually still available, and a transition
plan built without understanding the
origin can miss real opportunities.
Most concentrated equity positions
held by working professionals
originate through employer equity
compensation: stock options, restricted
stock units, or direct stock purchase
plans, frequently accumulated over
many years at a company the client also
depends on for their income. Options
carry their own tax wrinkle worth
knowing about specifically.
An early-stage employee receiving stock
options tied to actual shares (rather than
purely cash-settled equivalents) can
sometimes file an 83(b) election within
a strict window after grant, paying tax
on the then-low value of the shares
immediately in exchange for favorable
capital-gains treatment on all future
appreciation, rather than paying ordinary
income tax on the full value as the
shares vest later.
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A second, higher-stakes wrinkle
applies specifically to stock in a
qualified small business. Qualified
Small Business Stock, or QSBS, can
offer an exclusion from federal capital
gains tax on a meaningful portion of
the gain, subject to specific holdingperiod and company-size requirements
at the time of issuance, for stock
in certain C-corporations acquired
directly from the company.
For a client whose concentrated
position originated as founder’s stock
or an early equity grant at a qualifying
company, confirming QSBS eligibility
before finalizing any transition plan is
essential, since a position that qualifies
may warrant a substantially different,
far less urgent transition approach
than the Timeline framework below
would otherwise suggest. There’s
little reason to rush a Timeline-based
diversification of a position that may
already carry a significant built-in tax
exclusion, and an advisor who doesn’t
ask the question may recommend
an unnecessarily aggressive, and
unnecessarily costly, transition for a
client who never needed one.
TWO TRANSITION FRAMEWORKS
Two approaches dominate how
sophisticated managers handle this,
and they optimize for different things.
A Timeline approach transitions the
existing portfolio to the new target
strategy over a set number of years,
using security-level purchases and sales
