What's the Deal with Julius Baer's International Funds?

Sometimes it seems as if fund companies do things just to foment confusion. Two weeks ago,  Julius Baer International Equity (BJBIX) shut its doors to new investors. Yet that same day, the advisor opened a new fund with the same managers and a very similar strategy. Its name? Julius Baer International Equity II.

The original Julius Baer International Equity closed because of its burgeoning asset base; the fund has grown to more than $12 billion in assets from less than $600 million at the end of 2001. So why open a new fund? If that one is identical to the original version, doesn't that defeat the purpose of the closing? And if it's not identical, why give the new fund the same name?

The good news is that a look at the details shows the moves are part of a broad effort to handle an unusual situation in a reasonable manner. The result is not ideal; one could argue for alternatives. But the funds' shareholders should not conclude that their interests have been shoved aside, which would've been an understandable fear from a first glance at the news.

Some Encouraging Points
For one thing, the new fund has an important limitation: It cannot buy small-cap stocks. And it defines those broadly--companies smaller than $2.5 billion in market capitalization. That addresses a major concern. One problem with a growing asset base is that it can hamper the ability of a fund to profit from buying small, undiscovered companies with the potential for explosive growth--a skill that helped propel Julius Baer International Equity toward its outstanding long-term record. It's encouraging to hear that the new fund will not be adding to the pressure on that front.

Also offering some reassurance is that Julius Baer closed its internationally focused separate accounts, which had attracted nearly as much money as International Equity, in late 2004. However, that does leave two potential problems. Is the new fund attractive if it can't own small caps? And even with that restriction, could a deluge of inflows eventually cramp the managers' style nonetheless?

In fact, both funds will face a challenge matching the returns posted by the original fund during years when it could be as nimble as it wanted to be. Rudolph-Riad Younes--who manages both funds along with Richard Pell--conceded late last year that he would likely find it hard to outperform by as wide a margin in the future as he and Pell had in the past.

He was quick to add, however, that they could still outperform by a substantial margin. While such confidence coming from a fund's own manager must be taken with a grain of salt, the facts do provide some support. After all, the fund was never a pure small-cap portfolio. The overwhelming amount of its money has always been in mid-caps and large caps; many of its most profitable plays came from that territory. Moreover, in 2004, with its asset base already huge and growing rapidly, it beat 95% of the funds in its category.

Significantly, Younes says he's still able to invest meaningful amounts in East-Central Europe and in Scandinavian banks, which have been winners for the original fund over the past several years, as there are plenty of mid- and large-cap opportunities in those areas now. In late 2004, he bought enough of a Polish bank IPO to land it immediately in the fund's top 10. Likewise, the fund recently had 5.5% of assets in Turkey--a Younes favorite. Even after trimming that position during an early-year rally, the fund still has 3.5% of assets there and another 3.6% in Russia. Such actions serve as evidence that the fund will continue to chart its own distinctive course; it certainly won't be reduced to index-tracking. (Note that the MSCI EAFE Index has no weighting at all in Poland, Turkey, or Russia.)

A large cash stake would be a concern. But the fund has only 5% in cash, which for a mutual fund constitutes being almost fully invested. For a time last year the fund owned various index futures as a way to put cash to work, which could have been a sign of asset bloat, but Younes says they're gone now.

In with the New
So much for the old fund. What are the prospects for the new one? On the bright side, as noted above, it won't be shut out of the less-common destinations favored by the managers--as it might have been a decade ago--because such places now boast plenty of quality companies big enough to meet its market-cap hurdle. Younes says about 80% of names in the new fund can also be found in the old one. (Lacking a ticker symbol for now, the new offering has barely attracted any money beyond its $8 million seed money from Julius Baer.) He says that for the remaining 20% of the portfolio--a significant chunk, it should be noted--he added to the existing names or bought different companies as similar as possible to those off-limits. The managers are trying to keep sector and country weightings in line with those at the original fund so the two offerings' returns will correlate as closely as possible. That's a commendable goal, but we won't know for awhile how it works out in practice.

Indeed, don't take this as a blanket approval of every move the firm has made. In fact, one could make a strong case that shareholders of the original fund would have been better served if it had simply closed without any new version appearing on the scene. Sure, there's reason to believe the original can still prosper with the new fund around. But why not allow the first fund some time after its closing to become comfortable with its new size and situation and to see how much money keeps flowing into it before making a decision on whether to open up a very similar offering?

What's more, similar as they might be, the funds are not identical, making it doubtful that slapping a Roman numeral on the end of the name was the optimal approach. Younes replies that doing so was not misleading because the correlations between the funds will be high and they do have the same managers and strategy. Sad to say, the fund world does offer examples of pairs that don't even have the same managers ( Fidelity Equity-Income I (FEQIX) and  Fidelity Equity-Income II (FEQTX) form one of several such Fidelity non-twins) or that even have different firms running the portfolios ( Vanguard Windsor (VWNDX) and  Vanguard Windsor II (VWNFX) have completely different subadvisor lineups). Even so, choosing a different name would have lessened the chance of confusion.

It's also worth noting that at some point, rapid asset growth at both funds could create problems for the managers even with the small-cap limitation on the second offering. (For example,  Fidelity Diversified International (FDIVX) ballooned from $19 billion to $25 billion in the five months after it closed in October 2004.) Younes says the firm is watching closely and will consider taking further action if necessary, even to the point of imposing a "hard close"--i.e., prohibiting further investment even from current shareholders--on the original.

In short, it appears that shareholders of either fund will likely find themselves in an above-average offering, at the least, and that the advisor, though eager to continue gathering assets, recognizes the challenges it faces. But the advisor should not have been in such a rush to open a new vehicle--and should have provided that new fund with a distinct moniker that more clearly reflects its different mandate.