Sunday, 6 September 2015

Active performance with WisdomTree

WisdomTree (WETF) is an exchange traded fund (ETF) manager. They are the pioneers behind fundamentally weighted ETF's that weigh stocks based on fundamentals like dividends and earnings rather than market value. Their most popular products are international ETFs that hedge out currency movements. Their European and Japanese ETFs have been extremely popular with investors making them the 5th largest ETF provider in the US with nearly $60 billion under management. WETF have received the third largest inflows year to date behind only traditional market weighted indexes like Vanguard and Blackrock's iShares.

Source: WisdomTree investor presentation

Unique among fund managers 
WETF is the only listed pure play ETF manager it's a scarce asset with a superior business model to traditional managers. There is no key person risk and because they construct the indexes have little chance of sustained under performance. ETF's also benefit from first mover advantage once an ETF gains mindshare for their ticker the volume and liquidity this generates makes it very difficult for new indexes to gain traction. Also unlike other fund managers there are little concerns over capacity an index is much more scaleable than other investment strategies.

No key person risk
WETF have only 124 employees there are no expensive fund managers and analysts to pay bonuses out to. The employees they do have are exceptional. The chairman and largest shareholder is Michael Steinhardt a legend in the hedge fund world who returned 24% per annum over a 28 year period. Jeremy Siegel the Wharton professor and author of stocks for the long run is their investment strategy advisor.

ETF's are the new mutual funds
There are $2.1 trillion in ETFs in the US with $1.4 trillion in inflows since 2007 (see below.) WETF has taken 4% of those inflows. This ETF trend is likely to continue with advisor moves to fee for service. The US ETF market grew at 18% last year. If market share continues to grow (only 13% see below) assuming that ETF inflows total $3 trillion over the next 10 years and WETF continues to take 4% of these inflows. WETF will eventually have hundreds of billions of funds under management. As funds under management triple the stock should follow. Note these assumptions do not include the growth opportunities in Europe and the rest of the world who prefer the liquidity of ETFs based in the US. Their margins should also expand rapidly with this growth. It's interesting to see that WETF is not only one of the fastest growing fund managers but also already one of the most profitable.

Source: WisdomTree investor presentation

The balance sheet is nice and simple. WETF is asset lite with $189 million in cash, free cash flow is very attractive due to tax losses. It's also paying a 1.9% dividend with a $100m share buyback authorisation in place. The risk is a weaker dollar and poor performance from the European and Japanese markets that will impact inflows. This is the key risk but hedging is still low as a % of international ETF's being 15% of the international market. WETF have shown themselves to be innovative in coming up with new products, starting with a focus on dividends, emerging markets and currency hedging. Given their track record we believe they can come up with more fundamental products that the market needs.

Outperforming with a passive investment
WETF is the only listed pureplay ETF provider. Traditional funds management businesses are good businesses as they scale easily with very little people required. ETF providers have a even better business model. There is no key fund manager risk, it's hard to underperform when you create your own benchmark and indexes have few capacity constraints in how much capital they can manage. As advisers move to fee for service the move to passive ETF's is a trend that will likely continue. WETF now has scale but it's also small enough to keep growing. As an active manager it's a little ironic buying an ETF provider but their superior business model should help it to outperform the market.

Jason


Decisive has a long position in WisdomTree (WETF).The material in this article is for informational purposes only and in no way constitutes a solicitation of business or investment advice. The material has been prepared without regard to any client's or other person's investment objectives. Before making an investment decision you should consider the assistance of a financial adviser and whether any investment or service is appropriate in light of your particular investment needs.