Business owners and families may not even realize they are overconcentrated in either their operating firm or in certain assets or even liabilities
David Israelson • Financial Post
Published Nov 01, 2023
It is not something that is always on the radar for busy founders or family business leaders or wealth stewards. But the source of their wealth may also become a liability. Overconcentration is a problem that can arise particularly in large family portfolios because of the way the wealth was accumulated, says Arthur Salzer, founder, chief executive officer and co-chief investment officer of Northland Wealth Management, a multi-family office based in Oakville, Ont.
“The wealth in some families comes originally from a single-family business or venture. This can lead families to be overconcentrated in one area of investment for years, even decades,” he says.
Problems can arise when there is overconcentration in one area or asset class and families do not notice changes in their sector or the economy as a whole that affect their major holdings.
The dangers of overconcentration in holdings
Business history is filled with tales of families that built great department store businesses, for example, yet failed to diversify soon enough or fast enough.
“Such families did well by controlling their own companies. They got rich by hard work and a bit of luck and they grew their wealth faster than if they had started by investing in a diversified portfolio. That was the path to getting rich; the path to staying rich is through diversification,” Salzer says.
“In the first few generations of a wealthy family, it can take time for the family members to feel comfortable in diversifying,” says Russell Feenstra, wealth advisor and client relationship manager at Nicola Wealth, based in Vancouver. It also helps to be a bit dispassionate about the family business, even if family members are proud of it.“If you’ve built something, there can definitely be an emotional connection to what you’ve achieved, an affinity toward that specific asset. It can take time to separate from this emotion and move toward a more prudent asset management approach, built on diversification and cash flow,” he says.
“It doesn’t mean that the emotional attachment will change, but over time, individuals and families can start to look at other investment options for their overall holdings.”
“There is no set definition for what makes a concentrated position,” write Roger Young and Marty Allenbaugh of investment management firm T. Rowe Price in the United States.
“Once a holding exceeds 10 per cent of a portfolio, it represents a greater risk that requires more immediate planning,” they say. One sign that a high-net-worth portfolio is too concentrated in one area is when the invested assets are so locked up in one area that it is difficult to find the cash to invest elsewhere or seize market opportunities, Feenstra explains.
The solution to overconcentration is straightforward — diversify the portfolio. However, that can be easier said than done with a high-net-worth family’s large portfolio held by relatives who do not necessarily agree about a major recalibration.
How to diversify your portfolio
It takes soft skills as well as market analysis, Feenstra says. A strategy to help clients consider diversifying their wealth is simply to ask them to think. “What are their other long-term investment goals, aside from keeping their company profitable?” he says.“It helps families focus,” he says. Overconcentration comes up sometimes when holdings are largely dependent on the economy of one country or region, or one type of product that may be affected by new competitors or changes in the economy.
There also may be family feuds. “Generation One family members may be tied to a particular holding and want to keep it, even though the wealth is concentrated. The next generation may want to sell it and you have to work through the situation with the family,” he says.
If a portfolio is large enough, there may be enough funds to let different family members diversify the investments, Salzer says. He points to the Brazilian de Moraes family, with several billionaires and one of the richest families in South America.
“One of the family members wanted to invest in something non-traditional for the family — healthcare for people in remote areas. There was enough money in the family fortune to invest in this,” Salzer says. It benefitted people, as well as diversified the family’s investments.”
What risks to look for
Examining whether the family’s wealth is overconcentrated is particularly important for those whose holdings are in cyclical businesses where there can be dramatic rises and falls in value, such as commodities, Feenstra adds.
“We look at patterns. If one asset class is going up faster than other asset classes, in the long-term it could be riskier and falling faster,” he adds. Diversifying into other lower-risk areas, such as fixed income can help protect the portfolio from a roller coaster ride over time. “You also have to be aware of technology. It can change so fast and if you’re not careful the changes can wipe out your business completely, so you have to be aware of what changes are on the horizon and their potential effects,” he says.
It is also important to look at high-net-worth investors’ liabilities as well as their assets to make sure their debts are not overconcentrated, Salzer says.
“If you’ve only borrowed from one bank, you probably think that’s normal. But market conditions change; it can be a slow process but it does happen over time. You need to have comprehensive reporting on both sides of the ledger, so you understand if these are overconcentrated, too,” he says.