Until now, if a foreign fund company had a successful fund and wanted to give it exposure to the potentially lucrative U.S. marketplace, it has had to start from scratch and register a similar fund in the U.S. That may no longer be true. Julius Baer Group of Zurich may have found a way around that onerous process.
Julius Baer Investment Services of Boston, the entity which offers Julius Baer's Global Equity and International Equity funds, filed a preliminary prospectus with the SEC on April 9 that would create a U.S. fund, the assets of which would be invested together with an existing Swiss-based Julius Baer UCITS fund (Undertaking for Collective Investments in Transferable Securities), yielding a single portfolio of securities. If approved, it would mark the first time a company has used this approach with a U.S. fund, according to the registration statement filed with the SEC.
In order for this to work, Julius Baer is using a fund structure called the global hub and spoke model, developed by Signature Financial of Boston, according to the prospectus. The model has been used among domestic funds, but never with a U.S. and non-U.S. fund except for institutional funds, according to Phillip Coolidge, CEO of Signature Financial.
There are several advantages that this approach gives a fund company, said Coolidge. The most significant aspect of it is that it decreases the initial costs and time of starting up a new fund, he said. With the model, much of the fund management and operations are already in place.
"The fund company benefits from economies of scale," said Coolidge. "If the company was starting a brand new portfolio, they'd have to come out with portfolio management, time to select the securities, full fund accounting costs. Whereas, with this structure, most of that already exists in an existing portfolio."
Another advantage for a fund company is that it can use the previous investment performance from the European portfolio so that the new U.S. fund opens with a track record, according to Signature. While the new fund could not claim that performance history as its own, it can be made clear that the fund invests in, and will have the same portfolio as, the existing fund with that track record, according to Signature.
While fund companies enjoy these advantages under the arrangement, the hub and spoke holds no advantages for investors, according to Gregg Wolper, senior analyst at Morningstar of Chicago.
"I think it has advantages for the fund company rather than investors themselves," said Wolper. "For investors, it's really neither an advantage or disadvantage. Without the hub and spoke, fund companies would just open similar funds in the U.S. The investor is getting pretty much the same fund whether or not the same organism exists already or not."
Signature, however, said that investors could benefit from the model because the lower costs for the fund company could translate into lower expenses paid by shareholders to cover those costs.
"The portfolio of securities of the European fund ends up being in the hub portfolio, so what the U.S. investor is investing in is a pre-existing portfolio of securities with a track record, which is more than they would be investing in if it was a fund from scratch so they get the economies of scale that comes from that," said Coolidge.
Still, the expense ratio for the Julius Baer Swiss Stock fund would be 1.6 percent, according to the preliminary prospectus. That is only eight basis points less than the expense ratio for the average foreign stock fund, which is currently 1.68 percent, according to Morningstar.
The hub and spoke model works like this: the company first contractually separates the shared aspects, such as the investment manager and objective, the portfolio of securities and the safekeeping and trading arrangements, the "Global Hub", from the unique aspects, such as the fund name, pricing structure and distribution activities, the "Spoke," according to Signature.
"European regulators view the UCITS Spoke fund and the Global Hub portfolio as a single regulated unit" according to Signature. "As a result the laws of that particular European domicile apply to the activities of the Spoke fund and to the activities of the Global Hub portfolio."
The spoke fund owns specific securities, not an undivided interest in the hub, so financial statements issued by the spoke fund list a specific portfolio of securities like a normal fund, according to Signature. The spoke fund sends the cash from the sale of its shares to the global hub and withdraws cash from it to meet redemption requests and make distributions.
Registering the U.S. spoke is virtually the same as registering a traditional mutual fund, according to Signature. Consequently, the company must be a registered investment adviser in the U.S. in order to file documents and comply with the SEC. A foreign firm without a U.S. presence could not do so.
"While European regulators view the UCITS Spoke fund and the Global Hub portfolio as a single regulated unit, the SEC and IRS view the U.S. Spoke fund and the Global Hub portfolio as two separate and distinct regulated units," according to Signature's website. "The Global Hub portfolio operates as a partnership for U.S. tax purposes so that the UCITS Spoke fund is not adversely affected. As a result, the activities undertaken at the Global Hub portfolio level and the service providers which perform them must comply with SEC and IRS regulations as well as the laws and regulations of the European domicile of the UCITS Spoke fund."
Any investment restrictions that will apply to the global hub portfolio must be the more "stringent" of the European and U.S. rules, according to the preliminary prospectus. Also, the U.S. spoke would have a board of trustees to oversee the fund, as is the case with a traditional mutual fund.
Julius Baer declined to comment on the new fund until it is approved by the SEC. It is difficult to predict whether the fund will be approved and if so, when, according to Wolper. The SEC does not comment on pending matters.
"I'm not aware of any significant outstanding issues at the SEC, let me put it that way," said Coolidge. "Analytically, it's the same as the traditional hub and spoke from a U.S. regulatory and tax perspective."
If it is approved, the global hub and spoke model will be something that other firms might consider, but probably not in large numbers, according to Wolper.
"For fund firms, it simplifies matters" he said. "They can simply run the same fund, but less administrative and organizational rigmarole would be called for, so it does sound to me like foreign firms might go for it. I'm not sure that it will be much of a trend though because many foreign firms have already gained exposure here through acquisition or starting up funds already, but I think there will certainly be some interest."