GFX GLOBAL HUB AND SPOKESM SYSTEM
This Application of the GFX Global Hub and SpokeSM System permits a pension fund or other tax-exempt investor to combine the gross dividend tax treatment and investment flexibility of a separate managed account (SMA) or pooled account with the lower expenses and reduced tracking error or greater diversification of the larger portfolio of an ETF or investment fund.
The GFX Global Hub and SpokeSM System is the first that permits an investment management firm to operate a single GFX Portfolio with pension fund assets and assets from investment funds and/or ETFs sold publicly in the U.S. (mutual funds), Europe (UCITS) and Asia. Other SMAs for private clients, pooled private accounts, and banking, insurance, and other collective investment products are also able to invest through that same GFX Portfolio.
The GFX Global Hub and SpokeSM System results in:
- The most efficient and cost-effective portfolio operations through a single investment manager, a single safekeeper, a single auditor, single gross investment performance, and a single portfolio compliance platform across fund ranges and investment products, and across borders for the same active or passive index investment strategy,
- The most efficient tax treatment so that SMAs and pooled accounts would receive gross dividends if they qualified to receive them directly and would be subject to minimal, if any, security transfer taxes and stamp duty,
- The minimal level of expenses for each participating SMA or pooled account linked solely to the services provided through a GFX Portfolio and independent of additional expenses incurred directly by any other participating ETF or investment fund,
- The most effective new market entry through the critical mass and performance track record for new investment funds and/or ETFs with the domicile and other components selected independently from other participating funds in accordance with the applicable legal/fiscal requirements and market conventions of their intended market segment,
- Efficient and cost effective sub-advisory/private label arrangements between the investment management firm and its distribution partners through the creation of new participating funds sponsored by the distributor with the performance track record and critical mass of the other participating funds,
- The maximum investment flexibility through the ability to change, expand or modify the active or passive index investment strategy of a GFX Portfolio through the holding of additional assets or by entering into derivative contracts at the SMA or pooled account level, or by investing a portion of its assets through another GFX Portfolio, and
- Maximum liquidity through the ability at any time to withdraw all or a portion of its assets by withdrawing specific securities from the GFX Portfolio or to convert a portion of its interest in the GFX Portfolio into shares of a participating ETF and selling those shares on an exchange.
This Application is thus the next generation solution for pension funds and other tax-exempt investors to achieve the greatest efficiency from investment, expense control and fiscal perspectives, and for investment management firms to efficiently operate multiple SMAs, ETFs, and investment funds; effectively expand across borders and national market segments; create and operate enhanced sub-advisory/private label funds for their distribution partners; and employ sophisticated portfolio management techniques to customize a portfolio’s investment strategy for a specific national market or market segment.
GFX Global Hub and SpokeSM System
The GFX Global Hub and SpokeSM System involves the contractual separation of the portfolio components of the SMA, pooled account, ETF, or investment fund from the distribution, administration and shareholder recordkeeping components. Once separated, other existing or new SMAs, pooled accounts, ETFs, or investment funds can likewise separate their distribution, administration and shareholder recordkeeping components and invest through that same investment portfolio. This single investment portfolio is referred to as a GFX Portfolio and each of the SMAs, pooled accounts, ETFs, and investment funds investing through it is referred to as a participating SMA, pooled account, ETF, or investment fund, or collectively as participating investment products.
The following diagrams illustrate three parallel traditional investment products (Fig. 1), and those same three investment products participating in a GFXSM Portfolio (Fig. 2).
Fig. 1
Fig. 2
The GFX Portfolio operates as a single portfolio with a single investment manager, a single safekeeper, a single auditor, and a single portfolio compliance platform. Likewise, the GFX Portfolio has a single active or passive index investment strategy and set of investment policies and restrictions. The GFX Portfolio is tax transparent. The operations taking place through the GFX Portfolio comply with the laws and regulations governing each participating SMA, pooled account, ETF, and investment fund (the “highest common denominator”).
As a result, portfolio management, safekeeping and compliance functions are standardized and centralized across fund ranges and investment products, and across borders. The GFX Global Hub and SpokeSM System thus results in a more efficient and cost effective operation of multiple SMAs, pooled accounts, ETFs, and investment funds with the same active or passive index investment strategy.
The GFX Global Hub and SpokeSM System thus creates a single portfolio with assets from SMAs, pooled accounts, ETFs, and investment funds domiciled in different global markets. As a result, and unlike parallel traditional SMAs, pooled accounts, ETFs, and investment funds which have separate and distinct portfolios, the investments of the SMAs, pooled accounts, ETFs, and investment funds participating in a GFX Portfolio are held through the same single portfolio and are thus identical. They are thus normalized, i.e., each participating SMA, pooled account, ETF, and investment fund has the identical gross investment performance as each other participating SMA, pooled account, ETF, and investment fund investing through that same GFX Portfolio. Therefore, an investment management firm has the same gross investment performance across its SMAs, pooled accounts, ETFs, and investment funds for each active or passive index investment strategy. The net investment performance of the participating SMAs, pooled accounts, ETFs, and investment funds vary as the direct expenses of each vary depending upon its size and market dynamics.
Most Efficient Tax Treatment for Pension Assets
Each GFX Portfolio is fully tax transparent. As a result the tax treatment of dividend and interest income received through a GFX Portfolio is identical to that which would apply if the participating investment product operated in a traditional manner.
Thus a SMA or a pooled account with pension assets could receive dividends from securities held through a GFX Portfolio on a gross basis without withholding either at source or at the GFX Portfolio level.
In addition each GFX Portfolio has been structured to operate with a minimal or no securities transfer tax or stamp duty being incurred as the relative ownership of securities by the participating investment products resets from time to time.
A GFX Portfolio thus permits a participating SMA or pooled account with pension assets to continue to receive gross dividends and incur no transfer or stamp taxes on their investments while achieving reduced tracking error or greater diversification from a larger portfolio of securities and sharing, and thereby potentially reducing, expenses incurred from activities at the GFX Portfolio level.
Minimal Level of Expenses
As the portfolio components of an existing investment product are separated, so are the expenses (e.g., management fee, safekeeping fee) associated with them. These expenses then, in turn, form the basis for the expense ratio of the GFX Portfolio. As additional SMAs, pooled accounts, ETFs, or investment funds invest through that GFX Portfolio, that expense ratio should become lower as break-points in those fee schedules are reached. With two or more participating investment products, the transaction-based expenses (e.g., trading and settlement expenses) may also become lower. As a result, the aggregate expenses of each participating SMA, pooled account, ETF, or investment fund should be lower than they would be if that SMA, pooled account, ETF, or investment fund continued to operate in a traditional manner.
The expenses associated with the distribution, administration, shareholder recordkeeping and other components which a participating SMA, pooled account, ETF, or investment fund incurs directly, but which are not incurred by or shared with the other investment products participating in that GFX Portfolio, then form the basis for the expense ratio of that participating SMA, pooled account, ETF, or investment fund.
The aggregate expense ratio for pension plans and other investors in a participating SMA, pooled account, ETF, or investment fund would be the sum of the GFX Portfolio expense ratio plus the participating investment product expense ratio, which will be no greater, and most likely be less, than the expense ratio of that SMA, pooled account, ETF, or investment fund if it were operating in a traditional manner.
Since each participating investment product may have a different level of distribution and shareholder recordkeeping expenses, each participating SMA, pooled account, ETF, or investment fund would have an aggregate expense ratio which may differ from the aggregate expense ratios of the other participating SMAs, pooled accounts, ETFs, or investment funds.
Thus, investors in a participating SMA or pooled account incur aggregate expenses no greater than would be incurred if that SMA or pooled account were operating in a traditional manner and would incur expenses solely for services performed on their behalf, but not for services performed solely for investors in any other participating SMA, pooled account, ETF, or investment fund.
The GFX Global Hub and SpokeSM System therefore provides assurance to the fiduciaries and regulatory authorities responsible for a participating SMA or participating pooled account that it is incurring the lowest expense level possible for its size and operations.
Effective New Market Entry
The GFX Global Hub and SpokeSM System permits an investment management firm to create new participating Funds, ETFs, and pooled accounts customized for new markets or market segments that from creation would have critical mass (through the assets from the other participating investment products), and a performance track record (i.e., the track record of that GFX Portfolio adjusted for expenses).
Therefore, the GFX Global Hub and SpokeSM System is the most effective means for an investment management firm to expand across borders and across national market segments.
With respect to each GFX Portfolio, each participating Fund, ETF, pooled account or SMA can have a different (1) sponsor, (2) domicile, (3) name, (4) regulatory regime (e.g., investment fund, insurance, banking), (5) legal structure (e.g.,SICAV, unit trust, corporation, business trust), (6) pricing structure (e.g., total expense ratio, commissions, asset-based distribution fees), (7) valuation structure, (8) classes of shares, (9) currency of denomination, (10) distribution policy (e.g., roll-up, distributing), and (11) fiduciary (e.g., depositary bank, individual directors), in each case selected or determined independently from any other participating investment product in that GFXSM Portfolio.
Therefore, an existing investment product which has been operating in a traditional manner would not have to modify any of these administration and distribution components in order to participate in a GFX Portfolio. Likewise, a newly-created investment product can independently select whatever administration and distribution options are best suited for its intended markets and yet participate in a GFX Portfolio.
Efficient Sub-Advisory/Private Label Arrangements
The GFX Global Hub and SpokeSM System permits the sponsor/distributor of a participating Fund or other investment product to be unaffiliated with the investment manager of the GFX Portfolio. As with traditional sub-advised or private label arrangements, the sponsor/distributor of the participating Fund or other investment product is able to select or determine each of its administration and distribution components independently of the investment manager or any other client of the investment manager.
As a result, a participating Fund or other investment product would function as a seamless part of the sponsor/distributor’s product range in the same manner as would be the case with a traditional sub-advised or private label product. However, unlike a traditional sub-advisory or private label arrangement, the participating Fund or other investment product would commence operations with a critical mass of assets and a performance track record.
Similarly, the investment manager would have only a single large portfolio to manage, instead of two (one of which could initially be quite small) as would be the case with a traditional sub-advisory or private label arrangement.
In addition, if the sponsor/distributor of the participating Fund or other investment product chose in the future to internally manage its assets or select another sub-advisor, the participating Fund or other investment product could completely withdraw its assets from the GFX Portfolio without incurring any tax liability or need to sell any of the underlying securities. The securities withdrawn would be determined by a pre-agreed formula so that both the securities withdrawn and the remaining securities would constitute a commercially viable and diversified portfolio.
Maximum Investment Flexibility
Each participating investment product may also change, expand or modify the investment strategy of a GFX Portfolio for its national market or market segment. A participating investment product does this by holding additional securities at the investment product level, by entering into derivative contracts at that level, or by investing a portion of its assets through another GFX Portfolio.
For example, in addition to its investments in fixed income securities through a GFX Portfolio, the sponsor of a participating investment product could use derivative instruments at the investment product level to change the duration of its investments.
As a result, a single fixed income GFX Portfolio could have one participating investment product with a long duration, another with an intermediate duration, and a third with a short/intermediate duration.
Also, in addition to its investments in equity securities through a GFX Portfolio, the sponsor of a participating investment product could use derivative instruments at the investment product level to offset the exposure of the portfolio to specific national or industry segments, or to specific issuers or groups of issuers.
Maximum Liquidity
A participating SMA or pooled account may withdraw all of its assets in kind from a GFX Portfolio at any time. Each security position withdrawn would be pro rata, but rounded to the nearest commercially viable unit. Thus, upon a complete withdrawal, a SMA or pooled account would have a complete portfolio of securities without having incurred any withdrawal or brokerage fees.
A participating SMA or pooled account may also withdraw a portion of its assets at any time. Such a partial withdrawal would also be in kind and be in an amount equal to a redemption basket if effected by a participating ETF. Thus, upon a partial withdrawal, a SMA or pooled account would have a group of securities without having incurred any withdrawal or brokerage fees, and without any capital gains or losses having been realized for a participating ETF or investment fund. To obtain cash the SMA or pooled account would, as with a traditional SMA or pooled account, be required to sell some or all of the individual securities withdrawn.
A participating SMA or pooled account may also convert a portion of its interest in the GFX Portfolio into shares of a participating ETF which it could then sell on any exchange on which those shares are listed. Thus, upon a conversion which could be in any amount the SMA or pooled account would be able to obtain cash without the cost of selling individual securities.
Summary
The following chart is a summary of the benefits for a SMA or pooled account from investing with an ETF or an investment fund through a GFX Portfolio as compared to the benefits from investing directly in that ETF or investment fund, or from operating in a traditional manner.
| Traditional SMA or Pooled Account | Traditional Fund or ETF | Participating SMA or Pooled Account | |
| Tracking level (passive index) or Diversification (active) | High | High | Highest |
| Gross Dividends | Yes | No | Yes |
| Operating Expense Ratio | Lower | Low | Lowest |
| Liquidity | High, through sale of securities | Higher, through redemption of Fund shares or sale of ETF shares | Higher, through conversion to and sale of ETF shares |
Regulatory Status
The general legal, fiscal and regulatory issues underlying the GFX Global Hub and SpokeSM System were presented to the relevant authorities in the U.S., UK, Luxembourg and Ireland. The authorities in the UK, Luxembourg and Ireland confirmed that funds organized in those jurisdictions and operating as UCITS could participate in the structure. GFX believes that the issues raised in the U.S. have also been adequately addressed. However, as with other fund systems or structures – including traditional ones – no assurance can be given that, in the context of any specific application or filing, additional issues may not arise which would lead the applicable regulatory or fiscal authority to deny, reject or significantly modify that application or filing.
More Information
Global Fund Connections LLC (GFX) is a multi-disciplinary FinTech firm that has developed the know-how and software for this innovative GFX Global Hub and SpokeSM System. For more information concerning the GFX Global Hub and SpokeSM System, including its use by traditional investment funds, ETFs, SMAs and pooled accounts, or GFX’s know-how and software licensing program to implement and support it, or to be added to our mailing list, please contact us at info@GlobalFundConnections.com.
The principals of GFX have developed and operated many innovative fund structures over the past several decades, including the hub and spoke structure. The staff of the U.S. Securities and Exchange Commission reviewed that structure and concluded that “the organization of mutual funds in hub-and-spoke arrangements is an important evolution in the mutual fund industry.”
These development efforts have continued to evolve so that currently GFX is licensing to investment managers and their service providers the know-how and software necessary to implement and support the GFX Global Hub and SpokeSM System.
Copyright (c) 2014-2019 Global Fund Connections LLC. All Rights Reserved. “GLOBAL FUND CONNECTIONS” and “GFX” are registered service marks of Global Fund Connections LLC. “GLOBAL HUB AND SPOKE”, “GFX” and “GFX PORTFOLIO” are service marks of Global Fund Connections LLC.