Dan Silagi

WisdomTree: Riding the ETF Wave

Nothing wrong with investing in Wisdomtree's funds. My family and I intend to invest several hundred thousand, perhaps considerably more, into WSDT's funds, once they achieve a 1-year track record, assuming the funds at least perform in-line with the overall market.

But to value WSDT's current $1+ billion in assets (after 6 months) they way one would value, say, Procter & Gamble (in which I own far, far more stock than I do in WSDT) is missing the point. ALL growth stocks are ridiculously overvalued in their early stages, e.g., Google. The trick here is to determine which companies will remain growth companies three years from now, and which are selling "vaporware," of which there were many in the heady markets of 1998, 1985, 1967, and 1961, just to name four off the top of my head.

I suspect WSDT's recent growth spurt is due to its employees exercising stock options at year-end. Think they'd do it if they weren't optimistic about the company's future?

Also, consider the huge bonuses being paid to Wall Street employees this year. Most of these bonuses will be handed out in January. Some of that money will find its way into WSDT's funds. In addition, most institutions require a 3-year track record, meaning you need to wait 2 1/2 years before WSDT's funds meet that hurdle. I'm a (relatively) patient man.

I have read much of Jeremy Seigel's material, and as a University of Chicago MBA, who was schooled in the efficient market theory, am intellectually satisfied with his take on market inefficiencies, and with WSDT's prospects for exploiting them.

Of course, I could be dead wrong, which is why we own 6800 shares of WSDT, not 68,000 or 680,000. (Yes, I would have bought more if I have had access to tomorrow's paper today, but I don't.) Hence, I follow the cardinal rule of the efficient markets hypothesis, which is to diversify.

WisdomTree: Riding the ETF Wave

Comparing Janus to Wisdomtree is comparing apples to oranges. Janus has a market cap of $4 billion, 200 million shares outstanding, and about $160 billion under management. While they were very hot years ago, recently, their track record has been average -- in other words, they perform with the markets, not better. (Most mutual funds don't beat the market averages, and for that matter, neither do most hedge funds.)

The interesting thing about Janus is they only earned $100 million, or about 0.06% (0.0006) on each dollar invested. This, in spite of the fact that they charge 1% or so as a management fee. This is in part due to the legions of analysts and others they have working there.

Wisdomtree, and other ETF's, have computers do most of the work. Their overhead (and fees) will be much, much lower than Janus and its competitors. If Wisdomtree ever managed $160 billion in assets, you could be sure that they'll earn orders of magnitude more than $100 million.

WisdomTree: Riding the ETF Wave

Let's assume Wisdomtree has a steady $4 billion under management, and makes no money from securities lending, or any other source other than management fees. Let's further assume they make 50 basis points on each dollar (0.5%). Then their revenues would be $20 million.

I would be hard-pressed to figure out how a company operating out of not-very-expensive space in lower Manhattan, with a dozen or so employees, would spend $20 million. On what? Salaries? These guys aren't paid A-Rod money. Advertising? Compare with advertising expenses of listed corporations running ETF's.

The key to Wisdomtree's future growth is whether the alphas posted in backtesting (around 2%) are achievable in real-time. For that, a 3-year track record is needed before most institutions start commiting funds in a big way to a start-up. I personally want to see a years' worth of live data before I move the money I have in traditional index funds and market-cap ETF's into Wisdomtree, and I'm a big fan.

Assuming that Wisdomtree can maintain its alphas, the sky's the limit here. But that's a big assumption.

WisdomTree: Riding the ETF Wave

Bryne is absolutely correct; the revenue number is off by a factor of 10. But the revenue from fees in Wisdomtree's case is only a small part of the story; most ETF's earn income from securities lending. In Wisdomtree's case, the indexes are tailor-made to lend the underlying securities to short-sellers, notably from hedge funds. (This is one reason why there many of Wisdomtree's indexes are narrowly defined.

Remember, when one sells a stock short, the dividends belong to the lender, not the short seller. As Wisdomtree's indexes are based on dividends, and thus tend to overweight them as compared with the traditional market-cap indexes, this is even more important to Wisdomtree in generating income from securities lending.

Moreover, a next-year P/E of 23 is extremely conservative for a rapidly growing company. Google's is on the order of 60.

Watch the trading patterns of WSDT. While $10 a share is expensive now, if WSDT grows to $5 billion in assets in the next couple of years, which should be a piece of cake, you'll be kicking yourself saying "I shoulda bought at 10..."

Disclosure: We own 6800 shares, at an average price of 3 and change, and are kicking ourselves for not getting in at 1.25, which is when we starting watching the stock back in the days when it was IXDP.