New York-based ETF sponsor WisdomTree Investments (Nasdaq:WETF) announced its third quarter results and they were exceptional. Normally I don't write about small-cap investments, but when the only pure-play ETF sponsor available delivers news that outright refutes the perception you can't survive without rock-bottom fees offered by BlackRock (NYSE:BLK), State Street (NYSE:STT) and Vanguard, I just couldn't resist. WisdomTree could be the next big asset manager. Here's why.
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Dying on the Vine
According to Ron Rowland of the Street.com, the lifetime mortality rate for ETF funds is 17.3% with 300 out of 1,733 funds launched in the United States meeting their demise. Another 300 or so are on ETF Deathwatch, meaning one-third of the product launches to date have been unable to profitably sustain themselves. Most of the blame for the current situation comes down to a price war currently being waged by the big three. I believe, however, WisdomTree CEO Jonathan Steinberg has a better explanation for why his firm is thriving while many others including Russell and FocusShares falter.
In its Q3 press release, Steinberg said the following: "At a time when many ETF sponsors are competing directly against each other in market capitalization-weighted, beta exposures, WisdomTree's commitment to innovative, differentiated products has strengthened our competitive position in the industry." How right he is. The investment media, myself included, spend so much time focusing on MERs that we tend to forget that portfolio construction is still a critically-important piece of the asset management puzzle. WisdomTree's average ETF advisory fee for the first nine months of 2012 is 0.54%, significantly higher than many of its peers; yet it's attracted ETF net inflows of $3.67 billion year-to-date, 16.9% higher than in the first nine months of 2011. Higher fees, as it turns out, don't necessarily equate to bad business.
SEE: Easy-To-Understand ETFs
Third Quarter Results
Excluding litigation, shareholder proxy and initial exchange listing fees, WisdomTree's proforma operating income in the third quarter was $4.8 million, 200% higher year-over-year and 55% higher quarter-over-quarter. Total revenues in Q3 2012 were $21.7 million, up 22.6% from Q3 2011. I mentioned above that its net inflows YTD were 16.9% higher than a year earlier. In the fourth quarter of 2011, quarterly net inflows were $756 million. Expecting a significantly higher figure in Q4 2012, I would guess that WisdomTree's net inflows for 2012 could be over $5 billion, 28% higher than in 2011. In the first nine months of 2012 its non-GAAP pre-tax operating margin was 16% compared to 6% in 2011. If I were a betting man, I'd wager the 2012 annual non-GAAP pre-tax operating margin will be at least 20%. On that basis it should generate revenues of $84.5 million in 2012, pre-tax non-GAAP operating profits of $16.9 million and diluted earnings per share of $0.08. Most importantly, Q3 saw total revenues increase for the eighth time in nine quarters demonstrating consistent growth in its business model.
SEE: Analyzing Operating Margins
WisdomTree isn't immune to fund closures. On October 19 it announced that it was closing three funds with assets under management of $25 million or 0.15% of its $16.8 billion total AUM at the end of the third quarter. Two of the funds are single currency ETFs (South African Rand and Japanese Yen) and the third is the WisdomTree LargeCap Growth Fund (ARCA:ROI), a U.S. equity fund with an underlying index that screens for earnings growth. The three funds are the second, fourth and sixth smallest of WisdomTree's 49 funds in terms of assets; it's more a pruning issue than anything.
WisdomTree's future appears in emerging markets where four of its six funds with assets of more than $1 billion are located. Its biggest fund by a wide margin is the WisdomTree Emerging Markets Equity Income Fund (ARCA:DEM) with assets of $4.4 billion as of October 29. The fund takes the highest yielding 30% of the Emerging Markets Dividend Index, which is composed of dividend-paying companies from 19 emerging markets including Taiwan, Brazil, China & Russia. Two-thirds of the 233 holdings are large-cap stocks with the remainder primarily mid caps with some small caps as well. With a distribution yield of 5.93%, I can see why it's getting so much attention. Based on a 0.63% expense ratio, this particular fund will generate 24% of WisdomTree's estimated 2013 revenue of $115 million. The 12 emerging market funds it currently manages have assets of $9 billion, 54% of its total assets under management. Its five index-based equity funds, in turn, account for more than two-thirds of the emerging market fund assets and charge an average fee of 0.67% annually. It's hard to imagine a scenario besides another market crash where WisdomTree's financial position won't get stronger each quarter as it takes market share. Year-to-date its equity market share is 4.8% putting it in fifth place, 170 basis points behind PowerShares. I look for it to grow that number in the next year.
The Bottom Line
If you try to evaluate WisdomTree like you would any other financial company you'll likely pass on investing in it. It's important to keep in mind, however, that it's grown assets under management 55% annually since the end of 2008. Whatever happens in the ETF price war in 2013 and beyond, WisdomTree's figured out how to rise above it. Its stock won't be under $10 for much longer.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.