Sterling

Turning Concentration into Diversification with an Exchange Fund

With stocks trading at all-time highs, many investors are sitting on significant capital gains and may have positions that become untradable because of the potential tax implications. Whether the stock has appreciated over many years or accumulated as a company executive, dealing with a stock with a huge unrealized gain can become a good problem to have.

The risk is clear: If you stock takes a hit, it can have an exaggerated impact on your portfolio. However, you don't want to sell the position to diversify because of the potential negative tax implications.lucent

If you are holding onto a great company like Apple or Amazon, you may not worry about riding a big position in the company but what happens if the future looks more bleak. In our area, we have seen many companies like Lucent Technologies and Lehman Brothers go from Wall Street darlings to bankruptcy.

Enter the Exchange Fund

Exchange Funds or "Swap Funds," are private placement limited partnerships or LLCs. An Exchange Fund allows an investor to "exchange" highly appreciate stock(s) for shares in a fund of many pooled stocks that correlate with an index like the S&P 500 or Russell 1000.

Benefits of Diversification

The biggest benefit is allowing an investor to swap individual stock for a diversified stock fund without triggering any tax consequences. They will still have market risk but will remove the individual risk of a single company. Diversification can be an important part of maintaining wealth over the long term.

Who are Exchange Funds for?

The Exchange Funds are limited to accredited investors with at least $5 million in investible assets. Minimums are $500,000 in a single or multiple stocks.

Currently there are just two firms creating exchange funds: Goldman Sachs and Eaton Vance.

The other caveat is that the fund has to be willing to accept your stock. For example, if the fund has too much Apple stock, it won't be willing to accept anymore.

Potential downsides

There are a few potential downsides to Exchange Funds.

First off, to legally function as a partnership, exchange funds must invest at least 20% of assets in illiquid investments, typically real estate. Therefore, it isn't a pure stock portfolio.

Secondly, there are fees for management of the fund. This can eat into long-term returns.

Thirdly, there is also a 7-year wait if you want to redeem the shares as portfolio. Also, some exchange funds are illiquid for 7 years. At Goldman Sachs, they allow early redemption but at a cost of 1% in the first 3 years but they allow you to redeem.

Finally, you need to work closely with your CPA. The original basis is assigned to the basket of stocks you received. It is crucial for your CPA to be involved throughout the process to ensure proper record keeping and tracking.

In Conclusion

Exchange Funds offer diversification and tax-deferred investing without triggering capital gains tax in a concentrated position. For those who qualify and are looking to diversify concentrated low basis stock, they are definitely worth considering.

We can help clients decide if it is a right fit and also have a relationship with Goldman Sachs to give accredited investors access to the Exchange Fund. If you want to learn more and see if it the right fit for you, please contact us.

New Call-to-action

 

Share This Story, Choose Your Platform!

About the Author: Chris Wang

Chris Wang

IMPORTANT DISCLOSURE INFORMATION 

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Runnymede Capital Management, Inc.-"Runnymede"), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Runnymede.  Please remember that if you are a Runnymede client, it remains your responsibility to advise Runnymede, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Runnymede is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Runnymede's current written disclosure Brochure discussing our advisory services and fees is available for review upon request. Please Note: Runnymede does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Runnymede's web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Search Website

Annuity Review Database

Follow Our Podcast


Google Podcasts
Apple Podcasts
spotify

Recent Posts