This commentary originally appeared Feb. 8 at 9:45 a.m. on ETF Profits -- to access all the strategies from our team of ETF professionals, click here.
Exchange-traded funds have taken the world of investing by storm, acquiring more than a trillion dollars in assets -- much of it out of the pockets of pricey mutual funds -- and gaining traction with all types of investors as a better way to build wealth over the long-term and for short-term tactical trades.
While the ETF boom has helped investors keep more of their money, it has also become big business; the $1 trillion-plus in assets already generate a significant amount of management fees for issuers of these products, and that haul is expected to grow steadily as ETF assets climb.
My actionable idea for today is not an ETF, exchange-traded note, or any other kind of exchange-traded product. It's the stock of WisdomTree Investments (WETF), the only pure play, publicly traded ETF issuer. WisdomTree is closing in on $15 billion in assets among its nearly 50 different ETFs, and it is a major player in several key segments, including emerging markets, dividend-paying stocks and international bonds.
Last year, the company saw ETF assets climb by about 23% despite a challenging economic environment, and it is off to a hot start in 2012. January inflows of more than $700 million were better than any issuer outside the big four funds that account for about 90% of industry assets. Through Feb. 6, annual inflows were just shy of $1 billion, suggesting that 2012 could be the best year yet for the issuer.
WisdomTree is generating positive cash flows, impressive cash inflows to its ETF products, and continuing to expand its ETF lineup with innovative, first-to-market products that are quickly reaching a critical mass. WisdomTree Emerging Markets Local Debt Fund (ELD) and WisdomTree Managed Futures Strategy Fund (WDTI) stand out as a couple of relatively recent examples.
The future is bright for ETF issuers for several reasons. All signs point to continued growth in market share as investors continue to embrace the low cost and maintenance requirements of ETFs over mutual funds. Recent months have seen a long overdue intensification of scrutiny of 401(k) fees, and initiatives to both increase transparency and reduce costs have considerable momentum. Moreover, WisdomTree's first-mover advantage in dividend-weighted ETFs seems to be a huge edge, as do the considerably presence in the currency and international bond segments of the market.
Though the company is profitable, the price-to-earnings multiple implied in current valuations might seem lofty; for 2011, the company reported earnings of only about $0.02 per share. But the ability to leverage a relatively fixed cost structure will translate into huge improvements in margins for earnings before interest, taxes, depreciation and amortization in coming years as inflows continue and the asset base gradually grows. With an average ETF advisory fee of about 0.55%, every $1 billion in new inflows translates into an additional $5.5 million in annual revenue, most of which will drop straight to the bottom line. Considering the company made just under $900,000 in net income for the fourth quarter in 2011, that means pricing multiples are going to shift in a hurry in 2012 as margins skyrocket.
For investors looking to invest in the companies that are taking in the money generated from ETF expense rations, pure plays are hard to come by. IShares is part of financial behemoth BlackRock (BLK), and the ETF business is a relatively small part of the total company. The same goes for State Street, which performs a wide variety of functions in the financial space. For investors looking to gain exposure to an ETF issuer, WETF is the only game in town. As the ETF bug continues to spread, that could be a huge advantage for existing shareholders. With a sort of monopoly on the market, demand for WETF stock should skyrocket in coming years.
The downside to WETF is its correlation to the broader equity markets; WisdomTree's revenues move with its assets under management, meaning that a tumultuous environment can eat into earnings. But I'm extremely bullish on this stock over the long haul, and recently added WETF to my own portfolio. If you believe the future for the ETF industry is bright, it could be time for you to do the same.