You can imagine the surprise late last month, then, when that same WisdomTree rolled out a suite of six exchange-traded funds that weighted stocks, not by dividends, but by earnings. Was WisdomTree turning its back on the dividend system?
The initial reaction of many market observers was actually to cast the funds as the forgotten step-child of the dividend strategy; WisdomTree’s “second-best” product offering. But according to WisdomTree President Bruce Lavine, the new funds are anything but.
“We planned to launch the earnings funds from the start,” said Lavine. “We see the two families as complimentary, offering different things to different investors. Both families are rooted in fundamentals and both are alternatives to market cap-weighted indexes and ETFs."
According to Lavine, the earnings funds offer broader market coverage than the dividend methodology. WisdomTree’s calculations show that there are approximately 1,500 companies in the U.S. that pay dividends, for instance, compared to 2,400 that have earnings. The distribution across sectors is more even, too. In particular, dividend methodologies tend to overweight Financials and Utilities, while underweighting the tech sector. WisdomTree's small-cap U.S. dividend index, for instance, gives just a 1 percent weight to Technology; in the corresponding earnings index, that weight is closer to 15 percent. Investors who are uncomfortable with limited market coverage and skewed weights might turn to the earnings funds instead of the dividend products.
Lavine said that, of the fundamental factors WisdomTree examined, dividends produced the best risk-adjusted returns, while earnings produced the best absolute returns. Lavine doesn't see the need to introduce any further product families at this point, saying that the two are sufficient; other companies, however, are exploring alternatives. VTL Associates, for instance, is developing three revenue-weighted ETFs.
The new WisdomTree funds are all focused on the U.S. equity market, although WisdomTree plans to expand the series internationally as data and time allow. The funds weight stocks by the contribution to the corporate “earnings stream”: that is, the total dollar value of each corporation's earnings. The exception is the “Low P/E” fund, which, as the name suggests, buys only funds with low P/E ratios (i.e., the lowest 30 percent on the market.).
All of the funds rely on S&P’s “core earnings” measure, rather than reported earnings. The S&P measure aims to smooth the huge ebbs and flows in reported profits that result from non-cash charges.
The new funds are:
As WisdomTree builds out its earnings line-up, it will face a serious challenge in how to educate advisors and investors about the value of each product family. The company decidedly does not want its dividend-weighted ETFs to be ghettoized as "dividend-focused ETFs,” along with products like the iShares Dow Jones Select Dividend Index Fund (DVY); it has much larger ambitions for the funds, considering them potential replacements for cap-weighted indexes writ large. The company will need to tread a fine line between supporting the broader (and higher-returning) earnings funds, while maintaining that the dividend-weighted funds represent a real alternative to cap-weighting.