Why "walking down" a concentrated position by seeding ETFs could be problematic
As §351 transfers heat up... what could go wrong?
This article is educational content, not investment, tax, or legal advice. It is not an endorsement of any of the mentioned products. Read each prospectus carefully. Hire an adviser or tax attorney for personalized guidance.
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Why “walking down” a concentrated position by seeding ETFs could be problematic
Earlier this week, I did a quick analysis of Alpha Architect’s latest ETF launch, AAEQ.
AAEQ follows AAUS, launched in the summer of 2025 with north of $400 million.
Get up to speed on how to seed ETFs in-kind using Section 351.
Also check out my write-up on the strategy powering AAUS and AAEQ, and how the low-distro thing works under the hood.
Dividend chasers... YOU are the yield
Investors are so fascinated with yield... the chasing of yield is bloating prices that then deflate after distributions.
This is an exciting development.
Last December, I speculated that normies (i.e., everyday investors, advised and unadvised) seeding ETFs in-kind would pick up steam, and my book included a section about how ETFs might consolidate down the road using a so-called §368 reorganization.
“That’s the easy part,” Bill Davis of Stace Capital, which launched an ETF in-kind in 2024, and later merged it with another ETF via §368 reorg, told me earlier this year.
I included this little anecdote in my self-published book, The Adviser’s Guide to Seeding an ETF In-Kind (which is now sold out and I’m not printing anymore, sorry!).
It’s easy because it’s mostly governance checkboxes. There are relatively few things outside of the ETF sponsor’s control, compared to the §351 transfer, which deals with individual investors and their advisers, the 80% control requirement (and therefore market volatility), and various custodians, on and on. It’s a haul.
Bottom line: §368 is easier than §351.
Anyway. That’s a technical detail most people shouldn’t have to care about.
But nowadays, I see myself as a sort of informal tax risk manager, and as §351 transfers continue to grow in scale and frequency, there’s one risk that investors may stumble into that is mostly outside the ETF sponsor’s control.
I’ll call it “walking down” a concentrated position.
By “walking down,” I mean using a series of ETF seeds to reduce single-stock exposure step-by-step while staying under the 25% single-issuer limit each time (i.e., within the 25/50 framework).
Whether individual investors and their advisers know it or not, IRC §351(e) can deny §351(a) nonrecognition for transfers to an “investment company” that result in diversification. I wrote about this here.
So, if an investor has a beefy position and contributes a slice of it to a new ETF, then later on contributes another chunk of the concentrated position plus the first ETF to yet another ETF, you could imagine how they would systematically “walk down” a concentrated position without recognizing gain (illustration below).
The rest of this article discusses how investors may unintentionally (or otherwise) create diversification, which could be problematic if they are audited.
