We've all heard the old proverb "Money doesn't grow on trees!" enumerable times in our pre-teen and teenage years. The lesson of this saying is straightforward: become a productive member of your family and community, and gain your financial independence through work and service to others. Like many other life lessons, the principle is easy to grasp, but harder to execute, so the lesson is repeated until learned. We then build on this financial wisdom when we grasp the power of compounding, and learn that our money will work for us if we save and invest rather than spend and consume.
It is at this nexus of money, trees and investing that we find WisdomTree Investments, Inc. (WSDT.PK), an emerging exchange-traded fund sponsor. WisdomTree employs the powerful imagery and natural association between money, trees and investing to brand its investment products. Through the use of famous quotes and historical passages on trees, this article takes a look at WisdomTree as a business and portfolio investment.
"Someone's sitting in the shade today because someone planted a tree a long time ago." – Warren Buffett
WisdomTree is an investment management firm which develops domestic and international proprietary stock indices that serve as the basis for exchange-traded funds [ETFs]. The WisdomTree Indices cover all major market capitalizations, both domestically and internationally. In contrast to capitalization-weighted indices, the WisdomTree Indices anchor the initial weights of individual stocks to a measure of fundamental value using other company specific economic factors such as dividends or earnings.
WisdomTree ETFs are differentiated from their competitors based upon their proprietary, fundamentally weighted indexes which introduce a value discipline, or tilt, to index portfolio construction. WisdomTree has a patent pending on the methodology and operation of its indices. WisdomTree believes fundamental values provide a more accurate picture of a company's intrinsic value than its market price alone. In other words, WisdomTree systematically employs Buffett’s security selection mantra "Price is what you pay. Value is what you get."
Recent research from Morgan Stanley "The "Value" of Fundamental Indexing" confirmed this value tilt and found that domestic fundamental indices, such as WisdomTree Indices and the FTSE RAFI US 1000, had high correlations with traditional value indices, such as S&P/Citicorp Value Indices. Additionally, Morgan Stanley researchers looked at risk adjusted returns (Sharpe Ratio) for various indices over 1, 3, 5 and 10 year periods ended 2006. The relevant WisdomTree Large-Cap, Mid-Cap, Small-Cap and Broad Market Cap indices generally had the highest risk adjusted returns in their class of capitalization-weighted, equal-weighted and other indices over the various time periods examined.
"The creation of a thousand forests is in one acorn." - Ralph Waldo Emerson
Acorns appear only on adult trees, and thus are often a symbol of patience and the fruition of long, hard labor. Such is the case with WisdomTree. Its principal sponsors have long labored in the investment field as investor, academic and regulator: Michael Steinhardt, one of the hedge fund industry’s most successful investors, Jeremy Siegel, one of the financial services industry’s most prominent academics from Wharton Business School, and Arthur Levitt, former Securities and Exchange Commission [SEC] Chairman and noted investor advocate.
WisdomTree’s ETF orchard opened for business on June 16, 2006 when it launched the first family of fundamentally weighted indices and ETFs with an initial 20 dividend weighted ETFs. This launch included the first international small cap ETF listed in the U.S. and the first family of ETFs that track indices comprised of high-yielding international equities. The first mover advantage has historically been significant in the ETF industry. For example, State Street Global Advisors (SSgA) introduced streetTRACKS Gold Trust (NYSEARCA:GLD) prior to Barclays Global Investors launch of iShares COMEX Gold Trust (NYSEARCA:IAU). GLD currently has total assets of approximately $10.8 billion compared with total assets of approximately $984 million for IAU at the end of March, 2007. WisdomTree International Small Cap Dividend ETF appears to have also garnered this first mover advantage and is now WisdomTree’s largest fund at $475 million as of May 9, 2007.
On October 13, 2006, WisdomTree introduced 10 international sector ETFs. These are the first ETFs to offer pure international sector exposure as existing ETFs are based on a "global" sector model and contain a mix of both international and domestic securities. On February 23, 2007, WisdomTree listed six domestic earnings-weighted ETFs.
"They are like a tree planted near streams of water that yields its fruit in season; Its leaves never wither; whatever they do prospers." - Psalms 1: 3
WisdomTree has been very strategic with its product introductions. It has focused its ETFs in the three largest product areas – Domestic equities (Large-Cap, Mid-Cap and Small-Cap), International, and Sector & Industry. According to Morgan Stanley research, these areas represent 45%, 26% and 12%, respectively, of ETF market share at the end of March, 2007. WisdomTree was not only first to market with a family of fundamentally weighted domestic indices of various capitalizations, but its international ETF product offerings provide great breadth and depth by geography, capitalization and sector.
Of its 36 existing funds, 24 are internationally oriented. While non-US equities account for approximately 55% of the MSCI ACWI (all country world index), most US investors have a substantially lower asset allocation to international equities in the 10% to 20% range. It would seem reasonable to expect US investor’s to increase their international asset allocations over time in an era of increasing globalization, more rapid growth opportunities abroad, and recent outperformance of international markets compared to the US.
Recent research from Morgan Stanley provides some early insights on the effectiveness of WisdomTree’s strategies. US-listed ETF assets grew $11.6 billion for the first quarter of 2007 to $477.1 billion, or at roughly a 10% annual growth rate. Total industry domestic Large-Cap ETF assets declined $1.7 billion to $149.9 billion, or roughly 5% annually, while WisdomTree ETFs in this category grew $241 million to $626 million. Total industry International ETF assets grew $5.2 billion to $126.1 billion, or roughly 17% annually, while WisdomTree category assets grew much more rapidly by adding $994 million to $2.4 billion.
"He that planteth a tree is a servant of God, he provideth a kindness for many generations, and faces that he hath not seen shall bless him." - Henry Van Dyke
While there are obvious economic and personal benefits associated with the innovative undertakings of the WisdomTree sponsors, some of the public statements of the principals also reflect some more altruistic motivations. The following is an excerpt of the April 30, 2007 Barron’s interview with Michael Steinhardt, WisdomTree Chairman and largest shareholder:
Steinhardt says he "was attracted to the idea of an investment product that would be superior in its performance and have at the same time low cost, great liquidity and total transparency." What also made these ETFs appealing is that they offered a good product to average investors, which in his view have not been well-served by mutual funds.
"A fool sees not the same tree that a wise man sees." - William Blake, Proverbs of Hell, 1790
The market valuation of WisdomTree was broadly critiqued on limited information in a recent article in Economist on ETFs entitled "Revolution or Pollution?"
However, some worry that growth is getting out of hand, with valuations that recall the dotcom bubble. One ETF provider, WisdomTree, has seen the company’s own share price rise by 80% over the past year, even though it is yet to post a profit.
While WisdomTree has yet to post a profit, history tells us that successful investment advisory firms (Fidelity Investment, Vanguard Group, Fortress Investment, Blackstone Group) have been wonderful businesses to own. The attractiveness of the investment advisory platform reflects the relatively low fixed operating costs and significant operating leverage available with growth in assets under management. The greatest risk to the advisory model besides poor relative performance is runaway employee compensation. Wisdom Tree’s "passive" rather than active investment management platform significantly mitigates this risk. Meanwhile, history has not been as kind to most dotcom businesses.
Furthermore, unlike many dotcom companies whose only assets were intangible ".com" addresses and website hits, WisdomTree has $3.8 billion in assets under management (AUM) as of May 9, 2007 reflective of the tangible value of its intellectual property and its proprietary indices. Notably WisdomTree recently received two ETF industry awards for its innovative indexing methodology.
"Do not be afraid to go out on a limb ... That's where the fruit is." - Anonymous
So let’s inch out on a limb and review a few facts about the company before looking at valuation. Wisdom Tree is a development company and its shares trade on Pink Sheets. While WisdomTree does not currently file its financial statements with the SEC, its financial reports, including audited financial statements for the year ended December 31, 2006, are available here. WisdomTree recently announced that it intends to seek listing of its common stock on the Nasdaq Global Market by the end of 2007. In connection with that listing, the company would file periodic reports with the SEC. WisdomTree has 100.3 million shares outstanding and another 21 million of stock options, warrants, and restricted shares.
WisdomTree is engaged in a highly regulated and transparent industry. WisdomTree filed for and received exemptive relief from the SEC related to various provisions of the Federal securities laws necessary to create and market ETFs. The ETFs are marketed by WisdomTree Trust which is registered as an Investment Company with the SEC pursuant to the Investment Company Act of 1940. Its subsidiary WisdomTree Asset Management, Inc. serves as an investment advisor to the Trust and is a registered investment advisor with the SEC.
As of May 9, 2007, WisdomTree had an equity market capitalization and enterprise value (NYSE:EV) of $702 million at $7.00 per share and assets under management (AUM) of $3.8 billion. This represents an EV/AUM ratio of 19%. This approximates the EV/AUM ratio (20%) at which AIG Global Investment Group and Atlantic-Pacific Capital, Inc. bought 18.8 million shares (15.9% of Company on a fully diluted basis) at $3 per share on December 22, 2006 when AUM was approximately $1.5 billion.
In addition to these new, sophisticated investors buying in at this EV/AUM level, existing stockholders and directors of WisdomTree also purchased 3,050,000 shares in this offering. WisdomTree closed at $7.80 or EV/AUM ratio of 52% after the AIG announcement. While the share price has languished since then, WisdomTree’s AUM has grown 153%, or $2.3 billion, to $3.8 billion on May 9, 2007 in the 4 ½ months since AIG made its investment.
Like an acorn, WisdomTree has massive potential for growth and ample opportunity to grow into its valuation. The ETF industry is still in its infancy. AUM for the industry has grown from $100 billion at the end of 2002 to $477 billion at the end the first quarter of 2007. ETFs are highly competitive investment alternatives to the $10 trillion mutual fund industry given their enhanced efficiency, transparency and performance reliability. WisdomTree ETFs were intelligently designed and strategically planted, and are being warmly nurtured by their disciplined caretakers for future generations to enjoy. As the business matures over the next decade and longer, holders of the WSDT common shares will find that with WisdomTree "Money Does Grow on Trees."
Full disclosure: Long WSDT in diversified, more risk tolerant client and personal portfolios