| BUSINESSWEEK ONLINE : AUGUST 9, 1999 ISSUE | ||||||||
| ||||||||
 | ||||||||
| BUSINESSWEEK INVESTOR
Exchange Funds: Time to Swap 'n' Save? They can postpone your tax bill If your wealth is concentrated in a few stocks you bought before the equity market took off long ago, you may want to diversify. But doing so would mean selling some of those low-cost holdings and facing huge capital-gains taxes. You can broaden your portfolio and temporarily avoid this tax hit through an exchange fund. These increasingly popular private placements have recently attracted some $5 billion. Investors with large holdings in a highly appreciated stock can swap a portion, typically 20%, for shares in a diversified pool. Since this is a trade, investors entering a fund don't owe capital-gains taxes until they sell the holdings. Anyone who wants to invest must have liquid assets of at least $1 million--and, in some cases, $5 million--above the contributed shares' value. Money managers and banks such as Bessemer Trust, J.P. Morgan (JPM), Eaton Vance Management (EV), Salomon Smith Barney (C), and Donaldson Lufkin & Jenrette (DLJ) offer the funds. Exchange funds have some limitations. The Internal Revenue Service says 20% of an exchange fund's holdings must be illiquid. To meet the requirement, most funds buy special securities called partnership preference units, or UPREITS, issued by real estate investment trusts. Shares in the diversified portfolio are locked up for seven years, unless you die or the company whose stock you contributed merges with another. You can get your original contribution back before seven years, but then you'd be back where you started. At the end of the seven years, you can receive a diversified basket of stocks. You will pay capital-gains taxes if you choose to sell some of those shares, assuming you have gains. For example, say you own 10,000 Microsoft shares that cost you $7 apiece, or $70,000, that are now worth $100 apiece, or $1 million. You hand them over to the fund and get an interest in a diversified portfolio that could include stocks such as Coca-Cola, IBM, and General Motors. Seven years later, you withdraw this stock portfolio, sell the IBM shares, and pay capital-gains taxes. Your cost basis on those shares remains $7 apiece. If you want to invest in an exchange fund, the minimum is typically $1 million in stock, but it can be as little as $500,000 or as much as $20 million. Large-capitalization, household-name stocks are the focus of most funds, but a few buy mid-caps. Some managers will only accept shares of a company with three years of profits. Most funds close their doors after they reach a certain size and asset mix. Look for a manager who has well-defined goals and is clear about which stocks will achieve them. ''You want to know what type of fund you're investing in because it affects your asset allocation for seven years,'' says Beth Rodriguez, an attorney for J.P. Morgan. LIMIT DILUTION. Look for managers who have delivered good returns. After fees, Bessemer Trust's Meadowbrook Equity Fund, for example, has had an annualized return of 34.6% from its inception in November, 1995, through June, 1999, vs. 28.1% for the Standard & Poor's 500-stock index. ''The secret is to balance consistent performance over time,'' says Bessemer President Donald Herrema. If you're considering an exchange fund, think about your stock's future before you make a contribution. ''Make sure you're not diluting the upside potential that is left in your stock if you throw it into the mix,'' says Rodriguez. Also, if you live off dividends, exchange funds aren't for you because they reinvest their dividends. And exchange funds aren't cheap. Investors pay a onetime fee of up to 2% of the value of shares contributed, plus an annual management fee of 0.65% to 0.80% of total assets. But if a diversified portfolio is what you're looking for, the price might be right. BY TODDI GUTNER _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
|  |
 | |
RELATED ITEMS Exchange Funds: Time to Swap 'n' Save? TABLE: How It Works INTERACT E-Mail to Business Week Online | |||
