Excessive Concentration

 

Did You Suffer Investment Losses Due to Excessive Concentration? We Can Help

At Mika Meyers, PLC, our investor claims attorneys are committed to protecting the rights and interests of investors nationwide. If your financial advisor over-concentrated your investment portfolio in a single stock or a small number of stocks, the investment strategy may have been unsuitable for your investment objectives and risk tolerance, and your portfolio may have underperformed in comparison to suitable benchmarks. You may be entitled to financial compensation for your damages. If you have any questions about losses due to lack of diversification in your investment portfolio, please call (616) 632-8059 for a completely confidential initial consultation with one of our experienced and knowledgeable investor claims attorneys.

The Old Adage is True: Do Not Put All Your Eggs in One Basket

What is the goal of investing? For most people, it is a combination of protecting their wealth and generating positive returns. In pursuing those returns, we expose ourselves to different types of risk. However, some risks can, and generally should, be avoided, like the risk that comes from having an overconcentrated / under-diversified investment portfolio. When a portfolio is concentrated in the securities of a single company, or a small number of companies, the investor is exposed to a high level of “company-specific risk.” If the company performs poorly, or worse yet, goes out of business, the impact on the investor’s portfolio can be devastating. Investors can eliminate company-specific risk by constructing and maintaining a diversified portfolio of securities issued by many different companies. It is generally considered prudent to diversify across geographic regions, economic sectors, and industries.

What about asset classes? Should we diversify among stocks, bonds, and other types of investments. For most investors, the answer is yes. Different asset classes have different risk exposures, and perform differently under different economic conditions. Government bonds or highly rated corporate bonds are generally considered to be lower risk investments. Stocks, particularly small cap stocks, are considered higher risk investments. Historically, stocks and bonds have had low or negative correlations when it comes to their performance, meaning that stocks generally perform better than bonds under certain market conditions, while bonds will perform better than stocks under other conditions. The amount that we allocate to each asset class will impact the overall risk of the portfolio and influence how the portfolio performs indifferent market conditions. And, by selecting a mixture of asset classes with low or negative correlations, we can avoid devastating losses from market conditions that have a disproportionate adverse impact on a single asset class. For example, during the 2008-2009 mortgage crisis, portfolios that only contained stocks performed far worse than portfolios that included a blend of stocks and bonds.

The amount that should be allocated to each asset class will depend on each investor’s risk tolerance and unique investment profile. Advisors approach this issue in many different ways. Some advisors rely on the rule of thumb that the allocation to equity should be equal to 100 minus the investor’s age. Under this rule of thumb, 60 year-old investors should only allocate 40% of their portfolios to stocks (100 – 60). Other advisors may recommend a 60/40 allocation for all their clients. Some advisors use “tactical allocation” strategies, which involve adjusting allocations to different asset classes depending on the economic circumstances that exist. For example, an advisor may move a client from a 70% allocation in stocks to an 80% allocation in stocks in the early stages of a business cycle when economic conditions tend to favor stocks over bonds.

When Excessive Concentration Goes Wrong: Three Examples from Recent History

Imagine that there is a hot investment opportunity. While it makes sense to want to put a lot into it, the excessive concentration of assets can be a terrible error. The reason is that markets are fundamentally unpredictable. There is always the possibility that a particular company, asset class, or industry will suddenly take a nosedive. If your investments are not adequately diversified, you could be taking on a far higher level of risk than you are comfortable with. Here are three examples from recent history:

Great Recession (Nearly 60% S&P Drop Over Two Years)

Investing everything you have in a single asset class could be a big mistake. Even something broad like & the stock market & can fall dramatically when viewed as a single asset class. During the Great Recession, the S&P 500 experienced a nearly 60% drop from its peak in 2007 to its trough in 2009. Investors who were over-concentrated in stock market assets faced devastating losses. Even more alarming, many had invested heavily in real estate and financial sector stocks—which were among the hardest hit. The stock market losses for certain industries were 80% or even 90% from peak to trough. As the housing bubble burst and major financial institutions faltered, many people without diversified investments saw their life savings erode.

Puerto Rican Government Debt Crisis (Puerto Rico Bonds)

Municipal bonds are usually marketed as safe, secure investments—and that is often with good reason. However, just because an investment is "safe" does not mean that the principles of diversification do not apply. A great example comes from the Puerto Rican government debt crisis. For many years, Puerto Rico bonds were rated as safe investments. Investors who heavily invested in Puerto Rican bonds, attracted by high yields and tax-exempt status, faced severe losses when the government declared bankruptcy in 2015. This was the largest municipal bankruptcy filing in U.S. history, and it left bondholders with significant losses. Many claims were filed against brokers and brokerage firms who encouraged conservative investors to excessively concentrate their holdings in Puerto Rican government debt.

COVID-19 Hits (Oil and Gas Industry)

The COVID-19 pandemic severely impacted the oil and gas industry, illustrating the risks of sector-specific investment concentration. As global demand for oil plummeted due to lockdowns and reduced travel, oil prices fell dramatically. In April 2020, West Texas Intermediate (WTI) crude oil futures plunged to negative $37.63 per barrel, the first time in history that oil prices went negative. This unprecedented event led to significant losses for investors heavily concentrated in oil and gas stocks or commodities. For instance, the Energy Select Sector SPDR Fund (XLE), which tracks the energy sector of the S&P 500, fell by approximately 52% from the start of 2020 to its lowest point in March of that year. Major oil companies like ExxonMobil and Chevron saw their stock prices drop by around 40% and 30% respectively during this period. Investors with portfolios heavily concentrated in oil and gas stocks or commodities saw a huge, almost immediate drop in the value of their portfolio, highlighting the risks of excessive concentration in a single sector.

An Overview of Rules on Excessive Concentration: Best Interest Requirement

The Investment Advisor Act of 1940 imposes a fiduciary duty on investment advisors, which includes the duty to act in the client’s best interests. Similarly, the SEC’s Regulation BI requires brokers and broker-dealers to ensure that they are providing suitable investment recommendations that are in their customers best interests. These laws help to protect investors against the risk of overconcentration. Here are key things to know about how SEC laws apply to excessive concentration cases:

Your Financial Advisor Must Understand Your Risk Tolerance

In order to fulfill their obligations as fiduciaries or under Regulation BI, financial advisors are required to understand their clients’; investment profile and give advice tailored to that profile. Among other things, this involves a thorough assessment of the client’s financial situation, investment objectives, and how much risk they are willing and able to take.

Failure to Diversify (Excessive Concentration) is Contrary to Investors’ Best Interests

Securities regulators consider excessive concentration to be contrary to investors’ best interests, and routinely bring enforcement actions against advisors who fail to follow the fundamental tenet of diversification. Advisors must ensure that their recommendations do not unduly expose clients to potential losses from overconcentration.

Understanding the Benefits of Proper Diversification

The benefits of diversifying are well established and have been explained by FINRA as follows:

Asset Allocation

By including different asset classes in your portfolio (for example, stocks, bonds, real estate, and cash), you increase the probability that some of your investments will provide satisfactory returns, even if others are flat or losing value. Put another way, you are reducing the risk of major losses that can result from over-emphasizing a single asset class, however resilient you might expect that class to be.

Diversification

When you diversify, you divide the money you have allocated to a particular asset class, such as stocks, among various categories of investments that belong to that asset class. Diversification, with its emphasis on variety, allows you to spread your assets around. In short, you do not put all your investment eggs in one basket.

Risk Reduction

Proper diversification can help reduce both systematic risk (market risk that affects all securities) and unsystematic risk (risks specific to individual securities or sectors). By spreading investments across different asset classes, industries, and geographic regions, you can potentially minimize the impact of poor performance in any single area.

Potential for Steady Returns

While diversification doesn’t guarantee profits or protect against losses, it can help smooth out returns over time. When some investments in your portfolio are underperforming, others may be doing well, potentially leading to more consistent overall returns.

Why Trust Our Investor Claims Attorneys with Your Excessive Concentration Case.

Diversification of investment holdings is essential. Overconcentration has the potential to put an investor at a very serious risk. You could end up suffering far more extreme losses than is acceptable, given ordinary market risk. Financial advisors and brokerage firms must be held accountable for losses caused by overconcentration of investments. At Mika Meyers, PLC, we have a proven record of case results in fighting for the rights of investors. Grand Rapids excessive concentration attorney Daniel J. Broxup has the experience that you can rely on. When you contact our firm, you will be able to connect with abroker negligence attorney who can:

• Hear your story and answer your legal questions;
• Conduct a thorough review of your overconcentration case;
• Gather all relevant financial documents and records;
• Represent you in any settlement negotiations; and
• Take your case as far as needed to secure the best results.

Contact Our Attorneys Today to Discuss Your Claims for Excessive Concentration of Investments

At Mika Meyers, PLC, our excessive concentration lawyers are standing by, ready to fight for your rights. If your broker or advisor failed to properly diversify your portfolio (within or between asset classes), you may have a negligence claim based on the violation of Regulation BI and/or a breach of fiduciary duty against your broker/advisor. Mika Meyers regularly handles these types of claims on behalf of investors. For a free consultation, call investor claims attorney Daniel J. Broxup at (616) 632-8000 or contact us online. Your initial appointment is strictly confidential. From our law office in Grand Rapids, we handle overconcentration claims throughout the entire region.

Excessive Concentration of Investments: Frequently Asked Questions (FAQs)

How can investors protect themselves against the risks of excessive concentration?

Investors can protect themselves against the risks of excessive concentration by actively diversifying their investment portfolios across various asset classes, sectors, and geographic locations. A proper diversification strategy helps spread the risk and reduce the impact of poor performance in any single investment. Here are some specific steps investors can take:

1. Understand your risk tolerance and investment goals
2. Allocate assets across different classes (stocks, bonds, real estate, etc.)
3. Within each asset class, diversify further (e.g., different sectors for stocks)
4. Consider geographic diversification (domestic and international investments)
5. Regularly review and rebalance your portfolio
6. Consult with a financial advisor to ensure proper diversification

Remember to review and adjust your portfolio as needed, especially as your financial situation or goals change over time.

What should I do if I determine that my portfolio is not properly diversified?

If an investor discovers that their portfolio is overly concentrated, the first step is to assess the level of risk relative to their personal financial goals and risk tolerance. You may be able to identify that the current lack of diversification within your overall investment holdings puts you at a higher financial risk than you deem acceptable. Here are some steps you can take:

1. Review your current asset allocation and compare it to your investment goals
2.  Identify areas of overconcentration in your portfolio
3. Develop a plan to gradually diversify your holdings
4. Consider tax implications when making changes to your portfolio
5. Consult with a financial advisor for guidance on proper diversification strategies

If you have already suffered financial losses due to overconcentration—which is how many people discover that their portfolio is not properly diversified—you should speak to an attorney. They can help you understand your legal options and potentially recover losses due to unsuitable investment advice.

Is my broker or advisor liable if my account is over-concentrated?

If you have suffered damages due to excessive concentration of your portfolio, there is a good chance that you have a claim against your broker or advisor, either for recommending an unsuitable investment strategy or for breach of fiduciary duty. Brokers and advisors have a responsibility to:

1. Understand your financial situation and investment goals
2. Recommend suitable investments based on your risk tolerance
3. Provide diversified investment strategies to mitigate risk

If your broker or advisor failed to fulfill these responsibilities, resulting in an over-concentrated portfolio that led to losses, they may be held liable. However, each case is unique and depends on specific circumstances. If you have any specific questions or concerns about your case, contact an excessive concentration lawyer in Grand Rapids for immediate help.

Can I consult with an attorney about excessive concentration?

Yes, you can and should consult with an attorney if you believe you’ve suffered financial losses due to excessive concentration in your investment portfolio. An experienced attorney can:

1. Review your investment records and portfolio allocation
2. Assess whether your broker or advisor breached their duty of care
3. Explain your legal rights and options
4. Help you understand the potential for recovery
5. Guide you through the process of filing a claim, if appropriate

If you believe that you suffered financial losses because your broker or brokerage firm excessively concentrated your account, you should seek professional legal guidance. You may have a claim on the grounds of failure to diversify. Our investor claims attorneys specialize incases involving overconcentration / lack of diversification. We will help you understand your situation and determine the best course of action.