What Is an Exchange Fund?

An executive who often gets paid in shares, a private equity investor, and business founders whose company has completed an initial public offering tend to end up with large holdings of a single firm's stock. However, most investors want to diversify beyond one firm or even one market or type of asset. One way to do so without selling shares and being forced to pay taxes on capital gains is to join an exchange fund.

An exchange fund, also known as a swap fund, is a partnership among different shareholders, each of whom submits substantial holdings, usually in a single stock, into a pool in exchange for units in the entire partnership's portfolio. They thus diversify their holdings while deferring taxes on capital gains.

Exchange funds should not be confused with exchange-traded funds (ETFs), which⛦ are mutual fund-like securities that trade♕ on stock exchanges.

How Exchange Funds Work

Exchange funds are designed to appeal to investors who are in similar positions: holding 澳洲幸运5开奖号码历史查询:concentrated stock positions, often of highlꦍy appreciated shares, and wishing to diversify without paying capital gains tax. Typically, a large bank, investment company, or other financial institution will create a fund, targeting a certain size and blend of equity holdings. An exchange fund may be marketed to executives and business owners who have amassed positions that typically are centered on one or a handful of companies.

Participants in an exchange fund contribute some of the shares they hold into a pool with other investors' shares, with each receiving a pro-rated share of the 澳洲幸运5开奖号码历史查询:partnership's portfolio. Now each investor owns a share of a fund that contains a portfolio of different stocks. With each contri𓃲bution, the portfolio 😼becomes increasingly diversified, and so do the holdings of each individual investor.

Since no stock is actually sold, the investors don't have to immediately pay capital gains tax on any of their holdings of individual stocks, with that capital instead remaining invested in the hopes it continues to generate a return.

Some exchange funds include alternative investments such as 澳洲幸运5开奖号码历史查询:private equity or venture capital stakes, as well as real estate, bonds, and ETFs. Goldman Sachs (GS), Eaton Vance, and Cache are among the major firms that offer exchange funds.

Exchange Fund Requirements

Exchanged funds set minimum contributions for investors, from $100,000 to as much as $5 million. In addition, exchange funds typically require investors to be an 澳洲幸运5开奖号码历史查询:accredited investor.

To prevent triggering capital gains tax, exchange funds are required to implement a seven-year 澳洲幸运5开奖号码历史查询:lock-up period, which could pose a problem for some investors, and keep at least 20% of its assets in illiquid investments, typically real estate.

As the fund grows, and when enough shares have been contributed, it closes to new investors. Each investor is then given a stake in the fund based on the percentage of their contribution.

The Bottom Line

Exchange funds serve a particular purpose for a certain type of investor. For example, a senior executive may receive a large payout in company stock as deferred compensation. That payout may be so large that the executive's assets become unbalanced. If they want to diversify without immediately paying tax on selling shares of the company stock to get the cash to buy other assets, they can invest in an exchange fund.

Those who don't share the same needs—diversification, deferring capital gains tax—likely won't find exchange funds useful or attractive, particularly given the minimum holding period of seven years. But for those who need what exchange funds offer, they offer a unique solution.