Strategies for Portfolio Construction and Risk Mitigation

Part 3 in a series that steps through the allocation process for young allocators… First, decide the goals of the portfolio (don’t lose money, accept vol to make more money, strategy vs deals). Next, decide your investment beliefs and how you’ll construct the book (active v passive, alts - yes/no, liquidity and opp cost). Finally, you get down to strategy and interaction/correlation. 1. Now for the tricky part. You need to stay true to the goals for the portfolio, but everything can’t be leaning the same way. For example, it’s straightforward to construct a book that doesn’t lose money in a down market. But if the market is up, like 2010-2020, you’ll be relieved of duty before your portfolio outperforms. Similarly, the Regents may say they can accept market volatility, but if the book is down so much in a 2008 environment that the school has to dramatically cut its mission, you may not be around to see the rebound. So balance matters. 2. Diversification is important, but you don’t want to diversify away your alpha. Again, it’s tricky, and relates to your own risk tolerance as well as the risk tolerance of your IC. A good place to start is “how much can I lose (in actual $ or %) and either overcome it with another part of the book OR be able to sleep at night?” 3. To the extent that you DO take on more calculated risk in a certain part of the book, can you mitigate that in another part of the portfolio? Or are you just going to keep it small enough that the rest of the book can overcome it? If you’re right, does it increase the book’s return by 100 bps; if you’re wrong and it negatively impacts the portfolio by 50 bps, will you still be outperforming? If so, by how much? Is that sustainable? 4. Do you have sufficient liquidity to take advantage of opportunities? If all of your marketable strategies are 4-yr rolling locks, then no. So the terms you accept have to be consistent with the way you are trying to generate outperformance. We are active allocators on the marketable side, for example, so long locks don’t work for us, period. 5. Consistency of approach/tilt within a market matters. Because we are active (recognizing it’s not for everyone), multi-manager/multi-strat and most quant strategies don’t work for us. If we’re going to allocate to/from managers, we have to be able to determine when to do that. If the portfolio is meaningfully different from one week to another, we don’t know when to allocate. Thus, particular strategies fit differently into a book depending on how you are attempting to outperform. 6. It REALLY helps to evaluate the risk/return potential for a particular investment against ALL available investments, not just against those in a particular category or part of the portfolio. (That’s what TPA is trying to address.) 7. It’s ok to get things wrong. Either on the interaction w the rest of the portfolio or strategy or manager. Try again until you get it “right”! Cheers and good luck!

They came to the Bay Area with big dreams. Worked tirelessly. Climbed the ranks. Now, their company stock is worth millions—but they’re trapped. Suddenly, what was once a few RSUs became the foundation of their wealth. They were no longer just employees—they were investors in a company they believed in. But now, that same success feels like a trap. Their wealth is concentrated in a single stock. It’s growing, but so is the anxiety. 📉 One bad earnings call… 📜 One new regulation… 🚨 One market downturn… And everything they’ve built could come crashing down. They want to diversify. But selling feels like betraying their belief in the company. And taxes? That’s another headache. So what’s the solution? How to Escape the Stock Concentration Trap (Without Regret) ✅ Gradual Diversification – Sell in small increments to minimize tax impact while reinvesting in a diversified portfolio. ✅ Hedging Strategies – Use options like protective puts or collar strategies to safeguard against a sudden drop. ✅ Direct Indexing – Instead of buying an index fund, directly invest in the individual stocks within the index. This allows tax-loss harvesting to offset gains, making diversification more tax-efficient. ✅ Exchange Funds – Convert your concentrated stock into a diversified basket of stocks without triggering immediate taxes. ✅ Charitable Giving – Donate shares to a Donor-Advised Fund (DAF) or a Charitable Remainder Trust (CRT) for tax benefits + impact. ✅ Monetization Strategies – Use stock loans or prepaid variable forward contracts to access liquidity without immediate tax consequences. The goal? Align your investment plan with your financial plan. If you’re feeling handcuffed by stock concentration, it’s time to take control. P.S. I write newsletter for immigrant millionaires. 900+ readers are already in—join them here: [capital-we(dot)com/blog]

Diversification is a very specific thing that you can measure. It is the extent to which your portfolio's volatility (risk) is LESS than the sum of each position's volatility. It tells you how much "free-lunch" you're getting, which translates to not only lower risk, but into improved returns. You want the Diversification Ratio to be as high as possible. Because without diversification, the only other way of creating value is by stock picking or market timing. And good luck with that. To maximize the Diversification Ratio, you will want to diversify both types of risk: - Company Specific Risk - Market (Systematic) Risk Company specific risk is easy to diversify with index funds. For example, the std. deviation of the S&P500 is around 16%, while the weighted average sum of the std. deviations of the stocks in the index is around 32%. So depending on your measurement period, you're getting about a 50% reduction in risk without any reduction in return! But don't stop there. You still have the risk of the stock market itself to diversify. You could use AGG bonds like everybody else, but you might as well be holding cash. AGG bonds barely improve the Diversification Ratio at all. But if you used liquid alts to diversify the systematic risk of equities instead, you can improve the Diversification Ratio by another 40-50%. Take a look at your portfolio. I bet if you measured your Diversification Ratio, you would be diversified against company specific risk but have near zero diversification against market/systematic risk. This is why you're not protecting your client's to the downside, and why your portfolio has zero alpha vs the S&P500. Diversifying the systematic risk of equities is the biggest opportunity for adding value (alpha) that you are leaving on the table. It is so simple and intuitive. Yet advisors are still focused on trying to add value through stock picking and/or timing their stock exposure.