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WisdomTree Investments (NASDAQ:WETF)

Q3 2012 Earnings Call

October 26, 2012 9:00 am ET

Executives

Stuart Bell

Jonathan Laurence Steinberg - Founder, Chief Executive Officer, President, and Executive Director

Amit Muni - Chief Financial Officer, Executive Vice President of Finance and Principal Accounting Officer

Luciano Siracusano - Executive Vice President, Chief Investment Strategist, and Head of Sales

Analysts

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Jason Weyeneth - Sterne Agee & Leach Inc., Research Division

Steve Fullerton

Thomas Whitehead - Morgan Stanley, Research Division

Michael J. Grondahl - Piper Jaffray Companies, Research Division

Adam Q. Beatty - BofA Merrill Lynch, Research Division

Macrae Sykes - Gabelli & Company, Inc.

Todd Wachsman

Howard Rosencrans

Olly Ludwig

Operator

Good day, ladies and gentlemen, and welcome to the WisdomTree Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I'll now turn the call over to WisdomTree.

Stuart Bell

Good morning. Before we begin, I would like to reference our legal disclaimer available in today's presentation.

This presentation may contain forward-looking statements within the meaning of the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by these forward-looking terminologies such as believe, expect, anticipate and similar expressions suggesting future outcomes or events. Such forward-looking statements reflect our current expectations regarding future events and operating performance and speak only as of the date of this presentation. Such forward-looking statements are based on a number of assumptions which may prove to be incorrect. Forward-looking statements involve significant risks and uncertainties, should not be read as guarantees of future performance or results and will not necessarily be accurate indications of whether or not, or the times at or by which, such performance or results will be achieved. A number of risks and other factors could cause actual results to differ materially from the results discussed in forward-looking statements including, but not limited to, the risks set forth in this presentation and in the risk factors section of the company's annual report on Form 10-K for the fiscal year ended December 31, 2011.

Now it is my pleasure to turn the call over to WisdomTree's CEO, Jonathan Steinberg.

Jonathan Laurence Steinberg

Thank you. Good morning, everybody, and welcome to WisdomTree's third quarter conference call. Fellow shareholders, this was another great quarter for WisdomTree. We continue to execute extremely well across all functions. Highlights include: Record revenues of $21.7 million, up 22% from the year-ago quarter; record GAAP net income of $4.5 million with a pretax margin of 21% in the third quarter demonstrating our overall efficiency and margin expansion potential; we had $1 billion of net inflows and we ended the quarter with $16.8 billion in assets, a new quarter-end high.

In addition to this stellar operating results, we were productive on a number of other fronts. We completed our search for a Chief Operating Officer by hiring Greg Barton. I am pleased to be adding Greg to our already world-class team. On the product side, we launched one new fund in the quarter, China ex-Financials, as well as successfully repositioned another fund, which is now our new European Hedged Equity ETF.

Also significantly, we successfully renegotiated our joint venture with our long-time partner Bank of New York, on our currency and certain fixed income ETFs. Importantly, the effects of this will begin flowing through our financial statements in the first quarter of next year, ahead of our original schedule. Later on this call, Amit Muni, WisdomTree's CFO, will walk you through the benefits of that initiative, plus the rest of our financial results.

On the next page, let's look at the factors driving our assets under management. In light of our daily disclosure, much of what we discussed today is already known to those of you who follow us. So I will be brief with the data is "old news", but offers some insights around the numbers where useful.

We ended the second quarter with $15 billion in assets. We took in $1 billion in new money and we also had $700 million of positive market move to end the quarter with $16.8 billion in assets. On the right, you can see that our assets are up 50% over the last 12 months and up 12% from the prior quarter.

Let's take a closer look at industry inflows on the next page.

The industry had $58 billion in inflows, a strong rebound from a modest second quarter. In the middle column, you can see equities led all asset classes for inflows. On the right, we look at annual inflows. You can see that year-to-date inflows, the last column, at $132 billion are running ahead of the prior 3 full years. It looks like there is a very good chance that 2012 could top 2008 as the best year ever for the ETF industry in terms of inflows. Now let's look at WisdomTree's inflows.

As reported, our inflows this quarter were just over $1 billion and nearly $3.7 billion after 3 quarters. As you can see, we are running well ahead of where we were last year, which was $3.1 billion at this time. Let's take a closer look at inflows by category on the next page.

I want to draw your attention to the third quarter. Here, you can see what made up our $1 billion of net inflows. We experienced modest outflows in currencies as well as alternatives, but U.S. equities and emerging market equities led our inflows followed by foreign bonds. For the 9 months, our flows were dominated by emerging market equities with $2.6 billion of inflows with the nice contributions between U.S. and international equities plus foreign bonds.

Let's look at market share on the next page.

First, I want to remind you that WisdomTree currently has 1.3% of the industry's total assets, so any inflow above 1.3% means we are growing our market share. In Q3, we had 1.8% of the inflows, up slightly from the second quarter. For the 9 months, we had 2.8% market share. In light of the fact that the industry inflows this quarter were predominantly led by equities, I would've liked to have seen higher market share in the third quarter.

It was within the international developed equity space that we underperformed our market share. The category broadly had $5.5 billion of inflows and we had slight outflows of $55 million. More specifically, Japan had outflows this quarter, so we experienced attrition along with the larger category. And second, particularly in European equity space, we lagged. That subset had $1.5 billion of inflows, for the industry, we had slight outflows.

Let me discuss an action we took during the quarter.

As I mentioned earlier, we re-purposed an older ETF, or International Hedged Equity, into our new European Hedged Equity. We now have a more focused and extremely differentiated ETF offering for the European equity space. We hope to establish this fund as a strong alternative to unhedged European Equity ETFs. This fund is a potential solution for investors who want exposure to European equities, but have concerns the euro may depreciate. I am happy to report that this fund is up 68% in assets, though off of a small base, but still very positive since the re-purposing and trading volumes have also picked up. It's a good new beginning for this fund.

As you may member, we re-purposed a fund about 24 months ago, our Japanese equity ETF, where we decided to hedge out the yen exposure. That fund grew from $50 million before the re-purposing, to $528 million to date. We have great optimism for equities with currency overlays at the strategy. I hope that this was useful additional color on -- into our market share.

Let's look at equities, just equities on the next page.

We are pleased that we gathered $1 billion across our equity ETF family. Here, we took in 2.4% of the flows and we had the fifth most inflows among all ETFs sponsors. For the 9 months, again, we had the fifth best inflows with 4.8% share of equities.

We continue to position the company to be an asset gatherer in changing market cycles by expanding and refining our product set. I don't think our product set has ever been this well positioned. We continue to reaffirm our target market share of 3% to 5% of the total industry's inflows.

Now let's look at new funds launched year-to-date.

PIMCO continues to stand out in a tough market environment for new funds launched with their usually successful active bond fund. WisdomTree's approach to new funds can best be described as high-conviction launches where we aligned our sales team, our research and our marketing dollars behind our new funds. This year, WisdomTree launched 2 new funds so far. In the first quarter, we launched Emerging Market Corporate Bonds which currently has $84 million in inflows. And this quarter, on September 19, we launched China ex-Financials which has taken in $23 million. We are currently averaging $54 million in inflows per new fund, which ranks us third by that metric.

On the next page, let's look at our performance of our equity funds.

As all of you know, WisdomTree uses a proprietary index strategy for equities, commonly referred to as fundamentally weighted indexes. These charts show the percentage of our equity funds and the percentage of our assets under management that are beating their respective cap-weighted or competitive indexes. The less than 50% of our funds and assets are beating their respective benchmarks for the last 12 months, the 3 and 5 year, and since inception, numbers remain exceptionally strong. To be clear, we are showing our fund's performance, after fees and expenses, against indexes with no fees.

I know a lot of attention has been recently paid to the fee pressures on cap-weighted equity index ETF. What these charts show, for the sake of argument, even if our ETF competitors were to cut their fees to 0, because of WisdomTree's differentiated approach, strong relative performance, our overall value proposition would remain very much intact.

On the next page, let's look at WisdomTree's relative growth rates versus the other leading public asset managers and ETF sponsors.

Here, we are comparing year-to-date organic growth rates. Organic growth is defined as net inflows over the starting AUM. As discussed, WisdomTree's year-to-date inflows were strong and that led -- and that we led all public asset managers in organic growth. On the right, you can see that we also lead the top ETF sponsors year-to-date by the same metric.

This slide tells 2 important stories. First, the ETF secular growth story continues, with the ETF firm significantly outpacing their traditional mutual fund firms. As you can see, the ETF industry's organic growth rate was 13% compared to negative 1% on average for the traditional public asset managers. The second point is, within the fast-growing ETF industry, WisdomTree is still growing faster than the industry average and in fact, year-to-date, we remain the fastest growing of the 10 largest firms. This is an important slide for WisdomTree shareholders.

We remain the only publicly-traded pure play in the ETF space. We are benefiting from the secular growth of ETFs and within ETFs, we are executing smartly and remain well-positioned to continue growing our market share.

It is now my pleasure to turn the call over to Amit.

Amit Muni

Thank you, Jono, and good morning, everyone. I'd like to begin by first reviewing our overall financial results.

This was an excellent quarter for WisdomTree. The revenues reached a record $21.7 million in the third quarter, primarily due to higher average assets under management. Our pro forma operating expenses, which exclude the cost related to our patent litigation, ETF shareholder proxy and initial exchange listing fees, declined slightly to $16.9 million.

The third quarter is typically a lower expense quarter for us. Our pro forma operating income tripled from the third quarter of last year to $4.8 million, an increased 52% from the second quarter of this year. On a year-to-date basis, revenues increased 25% to $61 million, yet pro forma operating expenses increased only 12% and pro forma operating income was also more than tripled to $9.7 million.

The attractiveness of the operating leverage in our business model is beginning to emerge, and this is demonstrated when you look at our margins on the next slide.

Our gross margin, which is our total revenues less fund-related and third-party sharing expenses, increased to 68% in the third quarter compared to 61% in the third quarter of last year, and on a year-to-date basis, was 66% primarily due to change in mix of our assets that are part of our joint venture with the Bank of New York, as well as starting to reach pricing benefits with our third-party service providers. Our pretax operating margin also grew to 22% in the third quarter from 9% in the third quarter of last year, and was 16% on a year-to-date basis. Again, you can see the operating leverage in our business model as our AUM scales.

The higher margins were being driven by strong revenue growth, which we can review on the next slide.

Our ETF revenues reached a record $21.4 million in the third quarter. This was up 22% from $17.6 million in the third quarter of last year and $20 million from the second quarter due to higher average assets under management, which you can see on the bottom of this slide. On a year-to-date basis, ETF revenues increased 26% to $60.6 million.

Following in line with our inflows, our differentiated approach to equities continues to be a strong driver of our revenue growth, both on a quarterly and year-to-date basis. In particular, our emerging market equity ETFs which you can see in blue on this chart.

Our average advisory fee remains unchanged compared to the second quarter, at 54 basis points, and down from 55 basis points in the third quarter of last year due to the change in mix of our assets. As we published on our website, our average revenue capture remains at 54 basis points today.

Now let's review our expenses on the next group of slides.

First, I'd like to go through the major changes in our pro forma expenses. We have pro forma expenses of $17 million in the second quarter. We typically have higher transactional-related fund costs in the second quarter due to the annual rebalancing of our international ETFs. We did not have this level of expense in the third quarter. We also typically decrease our level of advertising and sales-related spending in the summer months, which decreased expenses an additional $697,000.

We also incurred lower stock-based compensation in the third quarter. Offsetting these decreases were higher fund-related expenses of $331,000 due to higher average AUM, higher crude incentive compensation due to our strong growth and additional headcount-related expenses, and lastly, $91,000 for other expenses. Those are the main drivers leading to the decline in our pro forma expenses.

The next slide goes through our expense line items.

I'll quickly go through the expense changes in the third quarter of last year, which can see on the chart on the top left corner of the slide. Operating expenses compared to the third quarter of last year are up 5%. Compensation cost increased 13% due to higher stock-based compensation, accrued incentive compensation, as well as headcount-related costs to support our growth. We have 70 employees today. Fund cost increased 11% due to higher AUM-related expenses. Marketing cost decreased 5% due to lower levels of advertising activities. We do expect our advertising expense to increase to more normalized levels in the fourth quarter. Sales cost decreased 13% due to lower product development-related expenses. Professional fees increased 4% due to executive recruiting fees. Third-party sharing costs decreased 33% due to lower AUM in our joint venture ETFs with the Bank of New York. Other expenses increased 23% due to higher overhead and administrative-related cost.

We obtained all the votes we needed for our ETF proxy solicitation and did not incur any additional expenses in the third quarter. We also incurred net legal expenses of $219,000 related to our patent litigation with Research Affiliates.

On the right-hand side of the slide, you can see that expenses continued to decline as a percent of revenue and we expect this trend to continue with higher asset as we gain operating scale in our business.

Our balance sheet and cash liquidity also continues to strengthen, which you can see on the next slide.

We have total assets of $61 million as of September 30, which is primarily comprised of $40 million of cash and cash equivalents, $9 million in investments, $9 million in revenues and -- revenue receivables from the WisdomTree funds. We had $124 million common shares outstanding and $139 million shares in total when you include our options in restricted stock. We also have a net operating loss carryforward of approximately $50 million.

Now I'd like to update you on 2 items. First, we have renegotiated our joint venture with the Bank of New York Mellon related to our currency and select fixed income ETFs. You'll remember back in 2008, we entered an agreement with the Bank of New York where we contributed our currency and fixed income ETFs, our sales force and expertise in product development and the Bank of New York contributed what they do for us in our equity ETFs, that is portfolio management, back-office fund administration and operational expertise in ETFs . We agreed, for a period of 5 years, we will split the net profit from this joint venture, 50-50. As of the end of the quarter, we had $2.1 billion in AUM from this joint venture ETFs and we have generated net profits of $21 million since inception.

So you can see, it was a great deal for both parties. We were able to launch these ETFs during a riskier time in the market to help broaden our product offering and the Bank of New York shared in higher economics than a traditional sub-adviser for taking on the market risk of launching these products.

As we have discussed with investors, we have been in discussions with the Bank of New York regarding the joint venture, and we are pleased to announce we have reached an agreement. This week, we agreed to end the joint venture effective the end of this year instead of March of 2013.

The Bank of New York Mellon is a valued partner to us and they have also agreed to continue to provide the services for these ETFs as they do for us today. However, the effective fees we'll pay them for these services will be more in line with the traditional sub-advisory relationship. Because of this change, we expect our gross margins to be between 70% to 75% in the near-term based on current asset levels and mix. This gross margin will continue to scale as we grow in assets, and at $40 billion in AUM and assuming the similar mix we have today, we expect our gross margins to be closer to 80%.

On the next slide, I'd like to walk you through how this change will affect our financial statement beginning in the first quarter of next year.

This slide will walk you through an example of the changes assuming the joint venture ended at the beginning of the third quarter. The first column shows our actual results we reported today. If the joint venture ended, the third party sharing line item which reflects the profit split we have with the Bank of New York, would be eliminated. In its place, we will incur fund -- new fund costs for the services that Bank of New York was providing to us as part of the joint venture. You can see we are eliminating more third party sharing expense than the new fund costs we would be incurring, resulting in net savings of approximately $500,000 which translates into an improvement in our gross margin and pretax margin.

As a reminder, we have given guidance that at $40 billion of AUM, we are targeting a 40% pretax margin and we do not -- we are not changing that long-term target as we have already incorporated some level of gross margin improvement in that guidance. However, I would like to stress 2 points. First, WisdomTree is in growth mode and we expect to continue to carefully invest in our business to be among the top 5 leaders of the fast-growing ETF industry. But we will carefully balance our investments in growth with improvement in our bottom line operating results. The second is this, as we have demonstrated currently, there is attractive operating scale in our business model, and just as we strive for ETFs to have the best performance, we are managing and targeting our business to have among the highest pretax margins of all publicly-traded traditional asset managers.

Lastly, I'd like to let you know about the changes we made to the Investor Relations section of our website.

As you can see from this snapshot from the homepage of the IR site, we have added several new enhancements including additional corporate information for shareholders and the ability to sign up for alerts. We have also added stock price information.

As you know, we publish our daily AUM, average AUM in the quarter, average fee rate in the quarter and weekly inflows that won't change from what you see today. But now, we have provided historical inflow and AUM information in Excel tables summarized by category, time period and by fund. As we have stated before, ETFs are about transparency, and we run our business to be intelligently transparent as well. We hope investors find this additional information helpful in an easily usable format to helping them analyze our business. And also, you can follow the WisdomTree ETF on our blog, Twitter and LinkedIn, so I hope everyone signs up for that.

Before I turn it back over to Jono, I'd like to give you an update on our results so far in October.

As of this morning, our AUM is approximately $16.7 billion. We experienced $131,000 in negative market movement and $48 million in net inflows as of yesterday. The more important statistic is that our average AUM has increased by about $1 billion, so we are trending to higher revenues again this quarter. You can see on the right, the majority of our flows had been into our fixed income ETFs in line with industry, but despite the fact the industry experienced outflows in equities, we have experienced inflows.

So to summarize, we produced strong financial results this quarter and demonstrated the operating leverage in our business as we continue to grow. We completed our negotiation with the Bank of New York which will result in additional financial benefits. I look forward to updating you on our full year results on our next call.

Thank you. Let me turn it back over to Jono.

Jonathan Laurence Steinberg

Thank you, Amit. WisdomTree launched our first ETFs in June of 2006. Over that time, a lot has happened to the asset management industry. The first chart is conventional wisdom. It shows that in the mutual fund structure over the last 6 years, bond inflows were more than $1.1 trillion, while equities had outflows of $350 billion, a difference -- a differential of $1.5 trillion. Most investors talk about what a fixed income world it has been, that's the conventional wisdom.

On the right, the second chart tells a very different story. It examines the same equity and bond flows, but this time in the ETF structure. This is the new world. Here, equities took in $600 billion and fixed income took in $200 billion. Both had inflows, but the equity advantage was a positive $400 billion. You can't say it's been a fixed income world in ETFs.

Now let's look at the new reality on the next page.

No longer is it prudent for investors in public asset management firms to only look at inflows separated by structure. I say you must look at the combined bond and equity cumulative net inflows for both mutual funds and ETFs. We have talked about ETFs taking 50% of the inflows over the last 5 years on prior calls. This is the new reality. What will the next 5 years or 10 years bring. For perspective, in 2002, 10 years ago, WisdomTree had developed a fundamentally-weighted approach to equities and had made the decision to own our own indexes, now referred to as affiliated indexing. These decisions in 2002 were being driven by the belief that there was and would continue to be fee pressure in commoditized cap-weighted ETFs. That the only value add in ETFs were in the indexes themselves, and that transparency, liquidity and tax efficiency would become the driving characteristics to success in asset management. We are seeing this play out in equities today. These charts show that the battle for new equity inflows is being won by ETFs. Equity ETFs took in $600 billion and equity mutual funds bled $350 billion, nearly $1 trillion differential. I don't think we will ever go backwards. I think equity inflows will forever be an ETF story.

What about the market share story in bonds? I think it's just beginning. For context, it's important to remember that the first bond ETF was launched in July of 2002, just 10 years ago, and almost 10 years after the first equity ETF. In fact, active bond ETFs weren't introduced until May of 2008, just 5 years ago. New innovations in fixed income, new strategies and the other asset classes like alternatives, plus new sales channels like 401(k), will fuel the next 10 years of ETF growth at the expense of traditional structures. The pie chart on the right shows just how vast the opportunity is.

These are truly interesting and challenging times for the asset management industry.

With that, I'm going to end the planned presentation and we will open this up for our phone calls or for questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Marc Irizarry of Goldman Sachs.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Jono, I was wondering if you can just talk a little bit about a lot of the news around this "price war" that's been happening with Vanguard and iShares. What's been sort of the response from the channel, if you will, from the RIAs in particular, and from some of the wire houses in terms of your ability to sort of differentiate your proposition? Has anything changed there?

Jonathan Laurence Steinberg

Thank you, Mark. Thank you for this question. So currently, we're not seeing any fee pressure. Aggressive pricing, as the presentation indicated, is not new. WisdomTree specifically was designed to address these exact market dynamics. 10 years ago, when we were building the business plan, domestic large-cap was 8 basis points at the low end. Today, it's as little as 4 basis point, so a 4-basis point change. This does not change WisdomTree's calculus in any way. I'm going to make a statement. I don't think any firm can more comfortably co-exist with Vanguard than WisdomTree. So that's sort of the backdrop. The positive is, first, Vanguard switching indexes, money is in motion. For the first time in a very long time, if ever, Vanguard has to explain themselves. Another real positive, indexes are being scrutinized. We think it's very positive for WisdomTree that people are looking under the hood at the underlying indexes, at the exposures that they're getting. A huge positive for us. Also a positive, the attention that aggressive pricing is getting from the media, from analysts, from the financial advisers, will help expand the ETF pie dramatically. I said in the presentation, for the first 9 months of the year, we're at $132 billion of inflows. So our record was about $178 billion. I would expect that we could do $180 billion to $200 billion of inflows this year and I wouldn't be surprised if we could do $250 billion in inflows next year. So I think it's all very, very positive. I think it's a legitimate question for the analysts to ask WisdomTree about the value proposition, or BlackRock about their value propositions and fee pressures. But I think the bigger story is, what does it mean for the traditional asset managers whose products get less and less competitive everyday? So I think it's all very, very positive at net-net of it all, and we're well-positioned for this trend.

Operator

The next question is from Jason Weyeneth of Sterne Agee.

Jason Weyeneth - Sterne Agee & Leach Inc., Research Division

You talked about fixed income being a big growth driver for the industry. I mean, I guess, how do you think you guys are positioned to take advantage of that, particularly given the scenario where you don't have a lot of products currently, and when you think about the domestic fixed income area, it's probably not a prudent part of the market to dive into?

Jonathan Laurence Steinberg

So we have a few bond funds, active bond funds, mostly or really, primarily foreign bond funds. We've chosen where we wanted to compete very specifically. Again, very aware of how certain cap-weighted fixed income categories have been commoditized. So we're very, very selective in what we launch. But between our relationship with Mellon and our new relationship with Western on emerging market corporate bonds, we should see more growth in fixed income and we see opportunities. Product development is always an area where we have to be very careful. We do want to tip our hands to our competitors, it's very competitive. But you will see more activity in fixed income over the coming year and years. We're very optimistic about it.

Jason Weyeneth - Sterne Agee & Leach Inc., Research Division

And I got on a little bit late, so you might have discussed this. But for the funds that you recently closed, I guess, can you talk a little bit about what, maybe, you didn't get right? And then similarly, sort of how you decide when the right time is to close them?

Jonathan Laurence Steinberg

So we announced, I don't know, a couple weeks or a week ago, that we're closing 3 very small funds that had been in the marketplace for quite some time. Two of them were currency funds, one was equity fund. So as an example, let me use the South African rand, as an example. The fund didn't attract much in terms of assets or trading volumes, and we looked at that space, sort of emerging market or commodity currencies -- emerging market currencies and commodity currencies, and the response that we got from the financial intermediary is that for the most part, they prefer our basket products. So we thought we would capture virtually all of the demand for that kind of exposure through the existing products that we had. So product management, closing funds is a normal part of our business, and we're just trying to be very efficient so that we can devote our resources, our people and energies to things that we think will be more receptive to the end customer. Jason, did I answer your question?

Jason Weyeneth - Sterne Agee & Leach Inc., Research Division

Yes.

Operator

The next question is from Bill Katz of Citigroup.

Steve Fullerton

This is Steve Fullerton filling in for Bill Katz. Can you guys provide an update on the patent infringement issue?

Amit Muni

Sure, we have really no update to mention. We're still in the discovery and deposition phase. The guidance that we have given to investors, as far as expenses, still stands, so we really have no updates to report.

Steve Fullerton

Okay. And then to the discussion you guys were having with emerging markets, the fee rate ticked up, you're having solid flows. So with the discussion on the commoditization pressure, what are you doing to differentiate yourselves there? Maybe this will talk to Slide 11. Do you have any numbers to how you're outperforming in that specific category?

Jonathan Laurence Steinberg

Luciano, would you like to take this?

Luciano Siracusano

Yes, we of course, post our monthly performance on our website. And so, in emerging markets, we've had some of our strongest relative performance, relative to the cap-weighted indexes. Our broadest fund, DEM, covers emerging markets equities. That's a $4.5 million fund since inception that's outperformed the comparable cap-weighted index by more than 6 percentage points annualized. So that's a very large number. It's also outperformed, I think, something like 99% of all of the actively managed open end mutual funds according to MorningStar. So we source that and report that data on our website. Certainly, we think, emerging market equity is probably the space where we have the greatest competitive advantages because we are the most differentiated. Our indexes typically start out with higher dividend yield since comparable cap-weighted and there's a 5-year track record now on certain of these funds and people can draw longer-term conclusions.

Operator

The next question is from Matt Kelley of Morgan Stanley.

Thomas Whitehead - Morgan Stanley, Research Division

This is Tom Whitehead filling in for Matt. Just wanted to ask a question on what you guys see as the potential for future exempted relief grants from the SEC. Could you comment on what they're looking for from applicants, the progress and the timing of it all?

Jonathan Laurence Steinberg

We -- so, this is Jono. We have very broad relief so we haven't been looking for new relief. But what we've heard is that the SEC has become very restrictive in granting new relief. There's varying degrees of relief, so there's traditional sort of third-party licensing of an index. That's sort of the easiest thing to receive, but it still takes time from the SEC. Active is harder. They put a ban, it seems, on the use of derivatives, something that we have the ability to do. So the SEC has been really quite the stumbling block for firms to get into the business. And we don't -- it doesn't seem that it's getting any easier at the moment. But that can always change. So we are not building our expectations that the SEC will remain a roadblock from future competitors forever, but at the moment, it definitely, for those that are in the business, it is a huge competitive advantage.

Thomas Whitehead - Morgan Stanley, Research Division

All right. All right. I guess, more -- you commented on the active and derivatives side. Anything, specifically, affiliated index. I believe that's another layer of complexity beyond your plain vanilla ETF. And any commentary there?

Jonathan Laurence Steinberg

The only thing that I would say is it always made a lot of business sense for WisdomTree. I always thought that this would be a way to, one, control the investing experience better, but also would be a better business model, not having the licensing fee. So if -- for the WisdomTree, it's really played out as a best-case scenario, exactly how we anticipated. I would imagine that this will become an area of future efforts for other firms. But again, I think that the SEC is just moving slowly in general with regard to ETFs.

Operator

The next question is from Mike Grondahl of Piper Jaffray.

Michael J. Grondahl - Piper Jaffray Companies, Research Division

Can you talk a little bit about what sales channels you're emphasizing today and which ones are kind of outperforming and which ones are maybe underperforming?

Luciano Siracusano

Well, this is Luciano speaking. We continue to have the same effort in the sales channel that we've had since October 2008. It's primarily the RIA channel has been leading us in inflows. The wire house channel including the regional broker dealers and the institutional channels is where we're spending most of our time. Year to date, I think we've seen improvements in the wire house channel in terms of both getting on to some additional platforms, getting on into ETF models. We've seen very strong flows there. But the RIA channel continues to perform at a very high level. So we're very fortunate to have inroads into both of those channels. And that's where we're going to continue the lion's share of our focus.

Michael J. Grondahl - Piper Jaffray Companies, Research Division

And then maybe just comment on the institutional channel. How do you think that's progressing?

Luciano Siracusano

I think it's progressing well. There, it's a little bit different in the sense that some institutions are -- have just been getting their hands around trading and using ETFs over the last few years. And there, I'm talking more about pension, foundations endowments. We also have been getting help with some of the consulting firms that are starting to incorporate WisdomTree ETFs into some of their recommendations. And so, I think there's definitely potential for growth on the institutional channel going forward, as well.

Operator

The next question is from Adam Beatty of Bank of America.

Adam Q. Beatty - BofA Merrill Lynch, Research Division

First, just a question on sales and business development and the expenses there. I appreciate what Amit said about sort of balancing growth mode with being careful around margins. Looks like the 9-month sort of year-to-date is down a little bit year-over-year. And I know the company's changed a lot in the intervening period. Just maybe some comments on -- I wouldn't really expect you guys to be taking your foot off the gas at this point. Maybe some comments about business development efforts going forward?

Amit Muni

Well, Adam, as I mentioned in my remarks, we're in growth mode and we're carefully managing, investing back in the business when the right opportunities present themselves with continued improvement in our bottom line results. You can see, from our sales and business development, that particular expense line item for the last 9 months, we spent a lot of money last year in some product development-related activities. We had a little bit of slowdown in new product launches this year and the amount that we've been spending are particularly related to just R&D on new products. But it doesn't -- it was just related to certain products that we were looking at, at the time. But again, our focus is to continue to innovate, continue to broaden our product offering, and we should continue to see continued spending in the sales and product development-related line items.

Jonathan Laurence Steinberg

Hey, Adam, this is Jono. I just wanted to add, when you look at the last few years, we've -- the industry has averaged only about $118 billion of inflows. So we've been appropriately conservative in this sort of a very lackluster investing market. You're starting to see a little bit of a pick up this year, we think, and it bodes well for future, maybe, for 2013. Things are a little slow just ahead of the election, but once you get clarity, just settling the future, I think that 2013 maybe a time where you'll see just greater inflows. And if it's appropriate, we'll be more aggressive, but you don't want to get ahead of it. So we feel very good with the way we've been anticipating the flows and the business model.

Adam Q. Beatty - BofA Merrill Lynch, Research Division

Got it. That's great context. And just maybe a follow up on sort of the pace of product launches. I guess, I've always thought, in terms of maybe 3 to 5 per year, do you expect to return to that pace next year, what's the outlook there?

Jonathan Laurence Steinberg

We've said 3 to 5. We've done 2 new funds and a re-purposed fund this year. We treat the re-purposed fund as a new fund launch. We feel that we've done, really, 3 new funds this year. And I think that pace is a good number for next year as well. So 3 to 5 is sort of what we were targeting.

Operator

The next question is from Mac Sykes of Gabelli & Company.

Macrae Sykes - Gabelli & Company, Inc.

Congratulations on the restructuring with the BNY. This may be difficult to quantify, but I was just curious as to how much new business is due to ETF reallocations to WisdomTree versus reallocations away from traditional mutual fund products. And I guess I'm asking you because iShares is going to be beginning that new re-branding campaign, and I just wanted to see if you might be a derivative of that.

Luciano Siracusano

Well, there isn't perfect visibility into the data, but I can just speak anecdotally in terms of what we see. And I think there's 3 major trends. On the wire house side, we continue to see advisers moving from transactional or brokerage-related business to a more fee-based business. And that works so ETFs work very well within the fee-based business. So I think that's one of the key drivers. A second driver is that there are money managers out there, particularly on the RIA side, who are now using ETFs in their models. Instead of buying individual stocks, they create their portfolio with ETFs. And so as they grow, it creates demand for exchange traded funds and WisdomTree participates in that, so we benefit. And I think the third major trend is just in a low return environment, I think people are more conscious of fees and taxes and that lends itself to people taking a look at the exchange traded funds instead of traditional actively managed mutual funds. So I would say those are the 3 big drivers that I see driving additional flows into ETFs and I see every reason that those trends will continue.

Jonathan Laurence Steinberg

Mac, this is Jono. Just -- when Luke spoke about really, in the wire house channel that the financial advisers moving from the active mutual fund businesses, WisdomTree's sort of rules-based active ETF approach is very well suited as a transition for new advisers that come into ETF. So we get to compete with Vanguard on one end and the traditional active mutual funds on the other end. It's a very, very big space, but we're a very good transition for those new advisers that, I think, are coming in large numbers now and I think in the future.

Macrae Sykes - Gabelli & Company, Inc.

Great. And just I noticed that currency ETFs have been trending down a little bit. Maybe you could go over the outlook for that and what are the drivers that flows into that product?

Jonathan Laurence Steinberg

It's really just dollar. It's just sentiment. These are on the other side of the dollar. The dollar's been very strong in recent years and no trend continues forever, so they'll have their debt.

Operator

The next question is from Todd Wachsman of Morgan Stanley.

Todd Wachsman

I have 2 different questions on completely different subjects. The first is, with the election coming up and the looming fiscal cliff and with the likelihood of higher taxes next year, do you think that the S3 filing that occurred the other day was largely due to that. In other words, if it looks like taxes are going to really sky rocket next year, might the secondary occur this year so they don't get slammed another, say, 8% or 9% or 10% in taxes. So I was wondering if you could give any guidance on the secondary, that was my first question. My second question was regarding 401(k)s. Really, just what progress are you making there and do you think it makes sense to effectively bundle some ETFs within an open ended fund structure just for 401(k)s that do not allow ETFs in their platform?

Amit Muni

Todd, this is Amit, I'll take the first question. So, yes. Last Friday, we did file a shelf registration statement and these -- this shelf only concerns shares being filled by Michael Steinhardt and RRE Ventures. Management is not selling any shares and the company is not selling any shares. I really can't comment beyond that regarding timing or anything else. I can just refer you back to the registration statement.

Todd Wachsman

Okay. All right. Well, it was just interesting because obviously, if they -- if it occurs this year, they'll save a lot of money on taxes. But -- and then about the 401(k), that was my next question.

Luciano Siracusano

Yes, on the 401(k) side, we are starting to see some increased activity and it is related to getting our ETFs into other structures. So right now, the most success we've had is in seeing RIA firms and money managers that are on 401(k) platforms and have a distribution capability there incorporate WisdomTree ETFs into their models. So to the extent that they can get an ETF model within 401(k) channel or create another structure that includes ETFs within it and get into the 401(k) channel as well as even the other channels. I think that's the way you'll see growth from WisdomTree. And there, I would just say that there's large custodians out there that are looking at making ETF-enabled options available. And I think in the next year, you'll probably hear some news about that and hopefully, that's the driver for ETFs within 401(k).

Todd Wachsman

Okay. Because I'd love to see more of the fundamentally-weighted WisdomTree ETFs within 401(k) plans, especially from outside providers that don't currently have that capability.

Jonathan Laurence Steinberg

We agree. We would like to see that as well. And the last -- the last thing on 401(k) was in the third quarter that transparency of fees emerged. So for the first time ever, when you got your statement you actually had some fee disclosure. So that should prove to be a very constructive catalyst for future ETF adoption within 401(k) plans.

Operator

The next question is from Howard Rosencrans of Value Advisory.

Howard Rosencrans

I'm a little surprised in the context of -- so it sounds like a very significant change in your BNY deal that you're not raising your guidance for your long-term pretax operating margins. Remind us, if you would, what was the 40% pretax margin target previously predicated on in terms of the gross margin, if you would?

Amit Muni

So the previous growth -- we had not given longer-term gross margin targets. We had given guidance that we expected to be anywhere between 65% and 68%. Now that we have renegotiated the joint venture with the Bank of New York, we've taken that short-term target up between 70% to 75% and at $40 billion in assets, we expect, at the current mix we have today, we expect that gross margins would be closer to 80% gross margins.

Howard Rosencrans

So there's a lot more points there that you now have to get back to still be at the same $40 billion, so.

Amit Muni

Again, I'll -- I guess, I'll say 3 things. First, as I already stated was when we gave that guidance, that we expect 40% of pretax margins at $40 billion of assets under management, we had already assumed some level of gross margin improvement in there. The second thing is, again, remember, what I stated is that WisdomTree is in growth mode. Our goal is to become one of the top 5 ETF sponsors and we're going to do that by continuing to invest back in the business when the right opportunities present themselves. But again, carefully managing our cost based so that we improve -- show improvement in our bottom line operating results. And the third is if you look at our results today, you can see the attractiveness of the operating leverage we have in our business model. Specifically, if you look at the ETF structure in our business model, we believe we can run our business. And that really is the mindset of this management team. We're going to run this business to be -- operate, once we get the scale at the highest pretax operating margins of any traditional asset managers.

Operator

The next question is from Olly Ludwig of IndexUniverse.

Olly Ludwig

I wanted to know if you guys could -- you've been talking about these gross margins and your benchmarking 80% gross margin with the $40 billion asset level at the current mix. I'm wondering, if notwithstanding the sort of perilous macroenvironment we're living through, if you might -- can you give us a little visibility as far as when that $40 billion might be reached. And in the nearer term record income, record revenues for the quarter that had just ended, is it likely -- are you keep -- are you likely to keep ratching it up and keep setting records along the way? Or are you reluctant to go out on a limb given the various variables of uncertainty that you guys have isolated this morning?

Amit Muni

So, we don't give any guidance on sort of timing because the large part of our results and when we'll reach asset levels depends upon the markets. And so, we can't project what the markets will do. But again, if you look at the operating leverage of our business, with continued asset growth, we should continue to see improvement in our bottom line results, continued improvement in gross margins. And that's just the beauty of the asset management business. And that's what we're demonstrating. Once you reach scale, there are true attractive margins that our business can reach. And again, because of the ETF structure and particularly, our business model, we believe that we can run our business at the highest margins of any traditional asset manager once we get the scale.

Jonathan Laurence Steinberg

And Olly, just one last thing that Amit touched on earlier in the presentation. Because of our transparency, you know that we're running, in the fourth quarter, $1 billion of higher average assets than the last quarter. So we're -- again, we are off to a good start in the very short-term.

Olly Ludwig

Are you guys surprised on the upside generally, all things being equal? Or is it kind of like what you guys have been planning for?

Jonathan Laurence Steinberg

Olly, we really have -- we're not surprised on the upside, we're not surprised on the downside. I think we have -- we came into this business with very realistic expectations and it's really panning out the way we expected.

Operator

[Operator Instructions] The next question is from Marc Irizarry of Goldman Sachs.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Great. It's just a long quick follow-up on the operating margin where it can go from here. Just, Amit, if you look at, I guess, the next near-term plan, if you will, in terms of comp, how should we think about headcount, where you're investing in the business and sort of what kind of leverage you can expect over comp if sort of the current run rate of the business continues?

Amit Muni

Sure. So, we'll give a little more clarity on sort of expense guidance in comp in particular on our next call when we look -- when we talk about our year-end results, we'll give a little bit more guidance. As we publicly -- as far as headcount growth from here, it's really incremental growth from here. We don't want to get ahead of ourselves. We want to continue to invest back in the business. Continue to expand our sales force. Continue to -- we need to add back into our back-office operations. But it's really incremental growth from here, going forward. So I think we'll give a little bit more guidance on our next call as far as our expense run rates and the like.

Operator

There are no further questions at this time.

Jonathan Laurence Steinberg

And I just want to thank all of you for your continued support and interest in WisdomTree and we'll speak to you at the end of the year. Thank you.

Operator

Ladies and gentlemen, this concludes today's program. You may now disconnect. Good day.

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