As tech stocks soar, executives use exchange funds to diversify wealth without selling

• Exchange funds pool concentrated stock positions from multiple investors into diversified portfolios that mirror benchmark indexes, with 80% in stocks and 20% in non-securities like real estate as required by the IRS
• Only accredited investors worth over $1 million qualify, and early redemption before seven years eliminates tax benefits and may trigger steep fees, with investors receiving back only their original concentrated stock
• Advisors recommend no single stock exceed 10% of a portfolio, and some strategists increasingly view exchange funds as wealth transfer tools, though getting clients to hedge remains difficult as they expect past outperformance to continue

Summary: Tech Executives Turn to Exchange Funds for Diversification

Wealthy tech executives and founders are increasingly using exchange funds (also known as swap funds) to diversify concentrated stock holdings without triggering immediate capital gains taxes. The trend has accelerated amid the AI-driven tech boom, which has created significant wealth but also concentration risk for employees holding substantial positions in single stocks.

Key Mechanism: Exchange funds pool concentrated stock positions from multiple investors into a diversified portfolio, allowing participants to exchange single-stock exposure for a basket of securities without realizing taxable gains. These funds typically hold 80% in stocks (mirroring indexes like the S&P 500 or Russell 1000) and 20% in non-security assets, primarily real estate, as required by the IRS.

Market Context: Strong market returns and ramped-up equity compensation packages at tech companies competing for AI talent have driven demand. Investment advisors generally recommend limiting single-stock exposure to 10% of total portfolio value.

Requirements and Restrictions:

• Only accredited investors qualify ($1M+ net worth or $200K+ annual income)
• Seven-year lock-up period required to maintain tax benefits
• Early redemption results in loss of tax advantages and steep fees
• Investors typically contribute only portions of their concentrated holdings

Strategic Uses: Wealth managers at Morgan Stanley and Northern Trust report clients using exchange funds for wealth transfer planning, helping narrow outcome ranges for legacy planning. However, advisors note clients often resist diversification due to emotional attachment to stocks that previously performed well.

Alternative Approaches: Some advisors, like Certuity's CIO Scott Welch, recommend more flexible strategies including collars, hedging, derivatives, or borrowing against stock positions, citing concerns about exchange funds' inflexibility during the lock-up period.