A customer’s account may seem diversified, but an advisor may have concentrated a portfolio on investments that are similar to each other. The failure to adequately diversify an investment portfolio can create an excessive risk of loss. Over-concentration can exist by investing a large portion of a client’s asset in one security, one sector or one industry. Sometimes, a financial advisor will recommend that most or all of their customers invest in the same products or securities. Portfolios should also be re-balanced from time to time to avoid excessive concentration related risks.
Over-concentration in a product, sector or security is a common reason why investors lose significant portions of invested assets. Over-concentration in general is not suitable for most investment portfolios and undermines the principles of prudent asset management. Over-concentration is problematic because an investor’s portfolio can be made excessively volatile based on the price-movement of securities within a single sector, industry, or stock. Concentration based losses can also be magnified when a financial advisor uses margin to purchase investments.
Examples of securities or sectors that have led to investor over-concentration claims include:
- Technology related stocks
- Real estate investment trusts – REITs
- Oil and gas investments
- Illiquid and Alternative investments
- Structured products
Many of these investments can be volatile and illiquid. Some investments or strategies generate high commissions and fees, which in turn incentivize financial advisors to recommend and hold them in large positions.
Some investors who own large portions of company stock and grants of employer stock options may require different strategies for diversifying their portfolio. Financial advisors have a fiduciary responsibility to the client to disclose all of the material risks of an investment and strategy and to provide suitable alternatives to holding concentrated positions.