Exchange fund
Also: exchange fund, swap fund, pooled equity fund
A private investment fund that pools concentrated single-stock positions from multiple contributors in exchange for units of a diversified portfolio. Contributions are tax-deferred under IRC Section 721.
An exchange fund, sometimes called a swap fund, is a limited partnership that accepts contributions of appreciated single stocks from accredited investors. Contributors receive partnership units tied to a diversified pool. The contribution is non-taxable under Section 721 provided the fund holds at least 20% of its assets in qualifying non-stock assets, typically real estate or commodity interests. After a seven-year holding period, the investor can redeem in kind for a diversified basket of stocks, carrying over the original low basis but with broad diversification.
Example: a tech executive contributes $5 million of a single-stock position with a $200,000 basis. Seven years later she redeems for a diversified basket of 50 stocks, each carrying pro-rata basis. No gain is recognized at contribution or redemption. Future sales of the basket use the carried-over basis.
Common mistake: ignoring the seven-year lock-up and the management fees of 50 to 150 basis points per year. A variable prepaid forward or collar may produce similar diversification at lower cost for smaller positions.
Exchange funds matter for executives and founders with $2 million or more of a single stock, a low basis, and no need for near-term liquidity.