LOS 15g. Statement in Schweser Re: ESOPs

A

archived_user

New member
Joined
Dec 7, 2011
Messages
0
Reaction score
0
p. 16 of book 2, SS 5, LOS 15. Regarding employees participating in an ESOP. We know employees should avoid high concentration of investments in company stock because it’s highly correlating retirement funds with current/future employment income. But, Schweser makes a statement, which is not explained as far as I can tell:
“An ESOP is an exception to the general aversion to holding the sponsor’s securities in a retirement plan. It does not expose the participant to high correlation between plan return and future job income.”
That’s the end of the paragraph and the LOS in this book. WHY is it not highly correlated? I don’t understand that at all.
Thank you!
 
are you reading that right?
Quote:
At times the ESOP may purchase a large block of the firm’s stock directly from a large
stockholder, such as a founding proprietor or partner who wants to liquidate a holding.
An ESOP is an exception to the general aversion to holding the sponsor’s securities in a
retirement plan. It does expose the participant to a high correlation between plan return
and future job income.
Click to expand...
 
Clark_CFA_Candidate wrote: ”An ESOP is an exception to the general aversion to holding the sponsor’s securities in a retirement plan. It does not expose the participant to high correlation between plan return and future job income.”
Click to expand...
My copy doesn’t include the highlighted word “not”.
Please recheck yours.
 
Opps. You’re right. Still, this doesn’t make sense to me:
“An ESOP is an exception to the general aversion to holding the sponsor’s securities in a retirement plan.”
Is that, assuming there is a discount? Even though it is specified that there is not always a discount. At the very least, the two sentences seem discongruent to me.
Anyway, you guys were totally right. It’s just that, when I read the first sentence in my quote, my brain was inserting that word, “not,” because as currently written in the book, it doesn’t quite make sense to me. Could you still understand my confusion here?
Thank you.
 
usually you would be averse to holding the plan sponsor’s stock in the pension plan. However this is an exception - given it is a DC plan - and the usual trend is for the employer to provide you the list of available stock you can invest in (a list) and the trend of folks to use naive diversification (1/n investing), some sort of home bias (that the employer is giving the go ahead to invest in the stock - so it is ok).
this leads to finding more DC plans having a lot of the employer’s stock as part of the investment strategy.
but once you do that - invest in the employer’s stock - when the company stock does not perform as well (because the company does not) there is a potential double whammy - i. you are at risk of losing employment. ii. your ESOP (DC plan) also tanks at the same time putting your retirement at jeopardy. That is what this is talking about.
 
Just off the top of my head with respect to exception to aversion, it might have something to do with ER matching, preferential tax treatment, limits on amounts purchased, etc. Sorry, but it’s late, I’m tired, and I’ve had a super rough week.
 
May I ask that given ESOP is considered a hybrid plan, where in the design is it DB-like?
Thank you.
 
You must log in or register to reply here.
Back
Top