For company founders and senior executives who built their wealth on the success of a single stock, having too much exposure to one asset can eventually become a problem rather than a benefit.

The long-running rally in technology shares has created enormous wealth for employees at fast-growing companies. However, concentrating a large portion of personal assets in just one stock also introduces significant risk. Many financial advisors follow a simple guideline: no single investment should account for more than 10 percent of an individual’s overall portfolio.

According to Rob Romano, head of capital markets investor solutions at Merrill, concentrated stock positions often represent both the greatest opportunity and the greatest vulnerability for clients at the same time.

For founders and early employees who have held shares for years, diversification is not always easy. Selling appreciated stock can trigger large capital gains taxes, reducing the amount available for reinvestment. As an alternative, some investors choose to place their shares into exchange funds, which are different from exchange-traded funds, despite the similar name.

Exchange funds, sometimes referred to as swap funds, combine stock contributions from multiple investors into a single pooled vehicle. In return, participants receive an ownership interest in the fund. After a predefined holding period, typically seven years, investors can exchange that interest for a diversified group of stocks that reflects their portion of the fund.

Although exchange funds have existed since the 1970s, interest in them has grown in recent years alongside strong equity market performance. The rapid expansion of artificial intelligence has played a major role in pushing technology stocks higher, further increasing stock-based compensation.

Eric Freedman, chief investment officer of Northern Trust’s wealth management division, noted that many publicly traded technology companies have increased equity incentives to stay competitive with emerging AI-focused startups when recruiting talent.

Most exchange funds allocate about 80 percent of their assets to publicly traded stocks, with the goal of tracking broad market benchmarks such as the S&P 500 or the Russell 3000. The remaining 20 percent must be invested in non-security assets to meet Internal Revenue Service requirements, with real estate being the most common choice.

Steve Edwards, a senior investment strategist in Morgan Stanley’s wealth management business, said he is seeing more clients use exchange funds as part of estate and wealth transfer planning.

He explained that exchange funds help reduce uncertainty. A single stock can experience extreme swings in value, while a diversified portfolio tends to smooth out outcomes over time. For older investors, this can be particularly important. A stock that performed exceptionally well for decades can suddenly collapse, potentially undermining plans to pass wealth on to the next generation.

Despite these benefits, Edwards acknowledged that convincing clients to reduce concentrated positions is often challenging. Many investors remain emotionally attached to stocks that have delivered life-changing returns and assume that past success will continue indefinitely. However, historical data suggests that stocks with strong past performance often lag the broader market in the future.

As a result, most clients choose to contribute only part of their holdings to an exchange fund, allowing them to lower risk while still maintaining exposure to the original stock.

Exchange funds are not available to everyone. Participation is limited to accredited investors, typically defined as individuals with a net worth exceeding one million dollars or annual earned income of more than two hundred thousand dollars for the past two years.

The lock-up period is another important consideration. Investors who exit an exchange fund before the seven-year term usually lose the associated tax advantages and may face substantial fees. In early redemptions, investors often receive their original shares back rather than a diversified portfolio, up to the value of their stake in the fund.

Scott Welch, chief investment officer at the multi-family office Certuity, generally advises clients to avoid exchange funds because of their lack of flexibility. He points out that there are other ways to reduce risk without committing to long lock-up periods. These include strategies such as collars, variable prepaid forward contracts, and tax-loss harvesting using long and short positions. For clients primarily seeking liquidity, borrowing against existing stock holdings can also be an effective solution.

Ultimately, while exchange funds can play a role in managing concentrated stock risk, they are just one of many tools available, and they may not be the right fit for every investor.