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WisdomTree: Growing Tip Of Big ETF Iceberg

Olly Ludwig


WisdomTree Investments launched its first 20 exchange-traded funds in 2006—one of dozens of upstart firms at the time with big dreams in a young ETF industry. Seven years later, those dreams have matured, and the company’s good fortunes represent the perfect example of how ETFs have become a serious threat to mutual funds that have dominated the world of investments for almost a century.

WisdomTree can now boast of being the No. 5 ETF firm by assets—fulfilling an early projection from the company’s leadership and demonstrating just how hot ETFs in general are becoming. WisdomTree is bringing its own heat as the sponsor behind the currently best-selling ETF in the world, the WisdomTree Japan Hedged Equity Fund (DXJ). The security is focused on Japanese equities and protects investors from the yen-weakening policies policymakers are pursuing there to help exporters. DXJ, now an $8 billion fund, has hauled in almost $6 billion this year.

Not least—and this is crucial—WisdomTree (WETF) is the only publicly traded asset manager focused solely on ETFs. That means that the company’s stock price—which has doubled so far this year—reflects not only the specific things WisdomTree is doing right, but also tells the tale of just how well an ETF industry that now commands more than $1.5 trillion in assets is doing these days.

“They are certainly the cleanest public example of the ETF industry,” said Jason Weyeneth, an analyst at Sterne Agee ' Leach, distinguishing WisdomTree from other public asset managers such as BlackRock, State Street and Invesco, each of whose ETF operations are but relatively small pieces of overall businesses that include mutual funds, closed-end funds and other non-ETF investment vehicles.

“The growth WisdomTree is generating is faster than the industry,” Weyeneth said, noting that the fact that the company’s “fundamental” indexes that screen securities for earnings and dividends are generally performing better than comparable capitalization-weighted index ETFs might be part of the reason for its healthy inflows. “But it would be difficult for them to be doing what they’re doing if the broader ETF backdrop wasn’t as favorable.”

Riding the success of funds such as DXJ, the assets in the New York-based firm’s 47 ETFs have climbed to more than $29 billion, lifting it the No. 5 position on IndexUniverse’s ETF League Table after starting 2013 in the No. 7 position. DXJ was also behind the sevenfold increase in its first-quarter profit, the biggest quarter in WisdomTree’s history.

More broadly, inflows last year into U.S.-listed ETFs came in at a record $188 billion , and the $64 billion in year-to-date inflows through April put asset gathering in 2013 on pace to top the 2012 record, according to data compiled by IndexUniverse.

Storm Clouds Have Passed

WisdomTree in the past few years has been garnering anywhere from 3 to 5 percent of industry inflows into ETFs, and its overall share of industry assets has been at around 1 percent, which explains why it has moved up the league table.

But, until late last year, those solid fundamentals weren’t reflected in the company’s stock price. That’s because two significant issues, now in the rearview mirror, were hanging over the company’s head.

WisdomTree ETF Net Flows



On the one hand, some of the company’s original investors, including legendary financier Michael Steinhardt, cashed out in a stock offering last November. The run-up to the transaction kept at bay investors who wondered how much the huge share sales might devalue the stock.

It all went off successfully, leaving the company with a solid base of largely public shareholders, and, given its listing on Nasdaq —a big stage to attract more investors—including institutions, said Weyeneth, who stressed that companies like WisdomTree that have market values in excess of $1 billion pretty much need to be on a major exchange.

As important was that in December Rob Arnott’s Newport Beach, Calif.-based Research Affiliates agreed to call off its patent infringement lawsuit against WisdomTree , which centered on who was the original innovator in the growing field of fundamental indexing. Both, is what the federal court ruled, and it ordered Research Affiliates to pay WisdomTree $700,000, unleashing WisdomTree’s stock.

As noted, WisdomTree's share price has doubled so far this year to $12.25, coinciding with DXJ’s large inflows—an industry-leading $5.87 billion so far in 2013. What’s unique about the stock is that it literally offers investors a piece of the ETF revolution without even requiring them to own ETFs.

True Believer

The era of the ETF seems to be coming into clearer view every day in the form of accelerating investment flows that in recent years have, in part, come at the expense of traditional mutual funds .

Also, the ETF represents a crucial new phase in the history of indexing that Vanguard founder John Bogle helped unleash almost 40 years ago with the launch of the world’s first S'P 500 mutual fund. Now, with index ETFs that trade all day long on major exchanges, investors can access broad swaths of the global investment universe with the click of a mouse, ushering in a new era where “asset allocation” has quite literally become a new asset class.

These facets of ETFs—from broad access, to immediacy of access to daily portfolio transparency—have created what ConvergEx Group Chief Market Strategist Nicholas Colas has called the “ETF ecosystem,” his own term for the way ETFs have arguably become the easiest way to read the tea leaves in markets and the macroeconomy.

Additionally, without question, the shift in the financial advisory business to fee-based advisors has sped up the adoption of ETFs, in part because it has allowed ETF sponsors to forgo onerous “12b-1” marketing fees that have contributed to higher mutual fund costs, and whose absence help keep a lid on ETF costs.

“I am completely biased,” WisdomTree’s Chief Executive Officer Jonathan Steinberg said in a recent interview. “But at some point you have to make a call and say this is a better structure. The ETF is the new force, and I have aligned all of my interests on what I believe to be the future.

“Everybody has to be more measured,” added Steinberg, referring to his public ETF competitors who also have mutual fund franchises they have to protect. “In that sense, I think we play an outsized role in communicating the future of the ETF industry.

“And by being public, we get to communicate the strengths of the ETF industry in a way that we couldn’t if we were private,” Steinberg noted, downplaying the grunt work required to comply with reporting requirements, such as the Sarbanes-Oxley Act.



An Indexing Company First

For Steinberg, WisdomTree began in the early 1990s as a financial publishing company called Individual Investor Group Inc. It was behind long-forgotten periodicals such as “Individual Investor” and “Ticker,” and it all went south when the technology bubble burst, after which Steinberg sold the media assets in 2000.

More germane to the tale of WisdomTree’s corporate lineage is that Steinberg kept intact the company Individual Investor's legal status as a publicly listed entity. That regulatory status of being public was kept in place even as the entity changed names and focus, and is a big reason WisdomTree is public today.

Additionally, and crucially, one of Steinberg’s interests that found voice in those early publications was indexing and its frontiers, which he made the centerpiece of his new ambitions. He renamed his company Index Development Partners Inc.—again, retaining the entity’s legal status as a public company, even though it had changed its name.

The Internet meltdown proved crucial as well to what Steinberg wanted to create, which was a new, rules-based method of indexing to capture the market’s returns. The need for this became clear with the “Cisco” effect.

The term became popular for describing how a high-flying stock could hijack an indexed portfolio’s returns and weightings on the way up and on the way down. This led a lot of innovators, including S'P, which developed an equal-weighted sibling to the original S'P 500 Index in 2002 to preclude this problematic aspect of cap-weighted methodologies.

Steinberg and his entourage—as well as Rob Arnott and his—have long argued that they have built better “mousetraps” than cap-weighting with their respective riffs on fundamental indexing.

The Wharton Connection

The company officially became WisdomTree Investments Inc. in 2005, but as it evolved into what it is today—an ETF company that started with indexes of its own creation—early investors such as Michael Steinhardt needed the assurance of a heavyweight that Steinberg’s new way of screening securities for earnings and dividends was indeed worth investing in.

Steinberg turned to economics Prof. Jeremy Siegel at the University of Pennsylvania’s Wharton School of Business—the alma mater of both Steinhardt and Steinberg’s father Saul—to kick the tires on this new fundamental-indexing methodology.

Siegel, in turn, asked his research assistant Jeremy Schwartz to do the grunt work on the task at hand. To those who just missed that reference, that’s the same Jeremy Schwartz who is now director of research at WisdomTree.

In other words, not only did Prof. Siegel end up endorsing Steinberg’s new methodology and go on to become a special advisor to the fledgling ETF company, the whole due diligence process led his best research assistant to find his dream job at WisdomTree.

“We went through it and we said:‘Wow, this is good stuff,’” Siegel recently told IndexUniverse in an interview. “I’ve never endorsed a product before, but I feel this is a product that I can endorse. We are going to beat the ‘value’ slices. That’s our goal—to beat value.

“With people seeking yield, this is going to be their vehicle for getting yield and protection against inflation. And the rotation is just at its infancy of moving into a dividend-weighted, value-oriented stock investment,” he said, suggesting Steinberg’s methodology has a very bright future.

The original crew at WisdomTree is still largely intact, and at the center of it all sits “Jono” Steinberg, who presides over a company that’s noteworthy for its combination of informality and intellectual rigor.

“There’s definitely an entrepreneurial spirit there, and it goes back to the roots of the company, with Steinberg setting out with this idea that there had to be a better way to index. And he sort of went out and found it,” said Sterne Agee’s Weyeneth.

“They’re excited about what they’re doing and what they’ve built, and they’re very excited about the runway for growth that they see,” Weyeneth added.


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