WisdomTree Investments Inc. (NASDAQ:WETF) Q4 2018 Earnings Conference Call February 1, 2019 9:00 AM ET
Jonathan Steinberg - President, Chief Executive Officer
Amit Muni - Executive Vice President, Chief Financial Officer
Kurt MacAlpine - Executive Vice President, Global Head of Distribution
Jeremy Schwartz - Executive Vice President, Global Head of Research
Jason Weyeneth - Director, Investor Relations
Conference Call Participants
Dan Fannon - Jefferies
Bill Katz - Citigroup
Robert Lee - KBW
Michael Cyprys - Morgan Stanley
Chris Shutler - William Blair
Michael Carrier - Bank of America Merrill Lynch
Brennan Hawken - UBS
Max Sykes - Gabelli
Keith Housum - Northcoast Research
Good day ladies and gentlemen and welcome to the WisdomTree fourth quarter earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. If anyone should require operator assistance during the conference, please press star and then zero on your telephone keypad. As a reminder, today’s conference is being recorded.
I would now like to turn the call over to Jason Weyeneth, Director of Investor Relations. Sir, you may begin.
Good morning. Before we begin, I'd like to reference our legal disclaimer available in today's presentation. This presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. A number of 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 WisdomTree's Annual Report on Form 10-K for the year ended December 31st, 2017. WisdomTree assumes no duty and does not undertake to update any forward-looking statements.
Now it's my pleasure to turn the call over to WisdomTree’s CFO, Amit Muni.
Thank you Jason, and good morning everyone. Since our operating data is already known, I’ll quickly go through the important items for the quarter, discuss our outlook for 2019, and turn the call over to Jon for some closing remarks before we open it up to Q&A.
Beginning on Slide 3, despite market headwinds we demonstrated positive organic growth during the quarter. Our global AUM was $54 billion at the end of the year; however, with net inflows and the market rebound in January, current AUM is over $58 billion, recovering much of the fourth quarter decline. Like all asset managers had this quarter, we experienced negative market movement of over $5 billion. Continued political and economic uncertainty in Europe, growth concerns in Japan, and a broader risk-off sentiment drove further outflows from HEDJ and DXJ. However, as the chart in the middle reflects, the rest of our franchise exhibited solid and diversified growth.
We saw the benefits of our April acquisition of ETF securities as commodity flows were strongest amidst the global equity market selloff, and we also saw robust demand for our fixed income ETFs where momentum continues to build. As you can see on the chart on the right, our geographical diversification efforts are paying off with inflows in Europe and Canada more than offsetting the DXJ and HEDJ-driven U.S. outflows.
Digging a little deeper into our U.S. segment flow highlights on Slide 4, we continue to see the benefits of flow breadth and depth from our strategic initiatives around advisor solutions, investments in technology, and new distribution channels and partnerships. The number of funds with creations on a daily basis remains above historical levels and the percentage of our assets in core funds continues to grow, generating inflows for the 13th straight quarter. At the fund level, we saw positive demand in our floating rate treasury fund USFR, which generated inflows of $790 million in the quarter with growth continuing into 2019. USFR has grown from just under $1 million at the start of 2018 to $2 billion today, reflecting client demand due to rising short-term rates, a flattening yield curve, and increased volatility of riskier assets.
Despite the substantial equity market selloff, our domestic equity and emerging market equity funds generated solid inflows with domestic equities recording their strongest flow quarter in two years, led by our large cap strategies DGRW and DLN. While AUM was pressured due to market volatility, flows into our core funds were positive for the 13th straight quarter, totaling $1.2 billion in the fourth quarter, the best results in at least four years.
Now let’s take a closer look at our international segment flows on Slide 5. The gold star this quarter goes to our international segment, which generated inflows led by our gold products as commodities shifted into favor and the funds we acquired from ETF Securities exhibited market leadership. Gold inflows totaled $667 million across the complex, representing 27% market share of Europe-listed gold flows compared to our AUM market share of 25%. We also had positive flows into our oil ETPs as the price of oil fell. Our UCITS had inflows of $223 million, also driven by demand for our broad-based commodity ETFs. Our Canadian listed products generated inflows of $85 million, driven by the launch of our core plus bond fund and flows into our quality dividend growth ETF. For the year, we generated over $300 million of Canada-listed ETF flows.
Now let’s turn to the financial results on Slide 6. Revenues were just under $68 million for the quarter, reflecting lower average AUM due to the significant pressure on global asset prices, as all asset managers experienced. On a GAAP basis, we had a net loss of $12 million, which included several non-operating charges. First, the increase in the price of gold led to an after-tax non-cash charge of $5.4 million for our future gold commitment payments. Second, we wrote off the carrying value of the option we have to purchase the rest of AdvisorEngine as we let the option expire. In the context of the challenging market backdrop at the end of the year, we didn’t feel it was prudent to exercise the option at this time, but we remain their largest shareholder. We have a great relationship with AdvisorEngine and are excited about our growth prospects with them. We also wrote down the carrying value of our intangible asset in GCC and ownership in Thesys Technologies. We also incurred $1.5 million of severance and other charges as part of our previously announced cost reduction initiatives. Finally, we incurred $800,000 of acquisition-related costs. Adjusting for these items, we earned $10 million or $0.06 a share in the quarter.
The adjusted tax rate in the quarter was 23%. As we look forward, we still expect a blended tax rate of roughly 26 to 27%. The lower rate in the fourth quarter reflected the benefit of tax windfalls from the exercise of low priced stock options. Please see the appendix of this presentation, where we disclose additional information on the tax effect of stock-based compensation on our projected tax expense in the first quarter.
Turning to the U.S. segment on the next slide, gross margins were 80.2%, down sequentially, reflecting lower average U.S.-listed AUM in the quarter, negative mix shift, recent product launches, and some seasonal charges associated with the annual rebalances of our ETFs. Adjusted operating margins for the U.S. segment were 23.7%, reflecting the lower revenue and gross margin. Total U.S. segment expenses excluding acquisition and severance-related costs increased 4% sequentially to $34.9 million, primarily by higher marketing and sales expenses which typically pick up in the fourth quarter. The compensation ratio for the full year was 27.4%, the low end of the 27 to 29% guidance range after adjusting for the severance cost.
Turning to Slide 8, let’s take a look at the financial results of our international segment. Gross margins were 69.1%, down sequentially, reflecting the higher cost due to timing of certain expenses. Adjusted operating margins for this segment were 18%, reflecting a decline in gross margins and modest growth in discretionary spending. Total international segment expenses excluding acquisition-related costs increased 7% sequentially to $18.1 million as we [indiscernible] scale benefits of the ETF Securities transaction and invest for accelerated growth in the region.
Now let’s turn to our 2019 expense outlook on Slide 9. We are updating some of the guidance metrics, first beginning with compensation. Previously we guided this line item as a percent of revenue; however, as we have experienced, volatility in our flows and revenues can lead to this line item being very difficult model. To allow you to better model this expense going forward, we are disclosing a dollar range that reflects the minimum levels of compensation to run our business and a high end if we meet certain internal targets. We expect compensation expense in the U.S. to range between $53 million and $63 million, and $17 million to $19 million for our non-U.S. business. There could be upside to the high end of this range if our results exceed our internal targets. We will give you updated guidance if we believe we are trending towards that.
Based on our current AUM and asset mix, we expect gross margins for our U.S. business to be between 80% and 81%, and 70% to 72% for our non-U.S. business. Both of these are near-term guidance numbers, and we will update these if we experience a change.
You have heard us talk about the benefits of entering into preferred or exclusive relationships with third party platforms. As we continue to build out these relationships, we expect that line item to be approximately 3.5% of revenues in the U.S. Given the market backdrop, we are holding all of our other expenses flat to annualized second half numbers which already take into account our previously announced cost reduction initiatives.
Our priority and focus is to make the right investments to grow our business to maximize value to our shareholders while at the same time managing our cost base. As our business scales, we will see upside in our margins with operating leverage across compensation, fund costs, and discretionary items. We have proven before we can achieve amongst the highest margins, and we can achieve those again. It’s all about scaling our AUM.
Now it’s my pleasure to turn the call over to Jon.
Thank you Amit, and good morning everyone. While 2018 was a frustrating year due to continued negative sentiment around the Japan and Europe themes, as well as the broad sell-off in global markets, we remain laser focused on what we can control, our strategy and our execution. As you know, a key priority over the past several years has been to improve diversification of our assets under management and position WisdomTree to generate organic growth in a broader range of macro environments. I am pleased with the progress that we made in 2018. As a tangible proof point, in the fourth quarter we were likely one of only a few public asset managers to generate positive organic growth despite continued outflows from DXJ and HEDJ.
This morning, I want to highlight three areas: our increased presence in commodities in Europe, our growing domestic fixed income business, and the fundamental changes we have made to our distribution. First on commodities in Europe, our acquisition of ETF Securities, Europe’s leading commodity ETP platform, in April was transformational. In addition to being immediately and significantly accretive to earnings, it was very strategic to us because the acquisition helped us to increase our presence in Europe, diversify our global product suite, and reduce the volatility of our assets under management. The fourth quarter achieved all of those desired and expected benefits.
During the fourth quarter, our $16 billion commodity franchise provided important growth, generating nearly $1 billion of inflows. Impressively, WisdomTree took in more than $0.50 of every dollar that went into Europe-listed commodity ETPs, an example of strong execution, and this momentum into commodities continued in January, where we captured inflows of $380 million.
Second, I want to comment on domestic fixed income. We began developing our domestic fixed income suite in 2013 with a focus on funds positioned to benefit from rising rates. As sentiment began to align, we executed well. Our domestic fixed income suite grew during the last 13 months by nearly 500% from under $500 million to, at the start of 2018, to just under $3 billion today. In particular, over the same 13 months our floating rate treasury ETF, USFR grew from just $1 million in assets to over $2 billion, and the fund has established itself as the asset and liquidity leader. This demonstrates that we can compete and win against larger firms in the very competitive category of domestic fixed income. We view success in domestic fixed income as strategically important in attaining our market share goals. With credit quality increasingly front and center on investor minds, we believe our first-to-market suites of fundamentally weighted and strategic core bond ETFs are well positioned to complement the growth of our rising rate products.
Finally on distribution, we have made several changes to best position us to thrive and drive fast organic growth going forward. While we are still early in the execution, we did achieve over $3 billion in net flows from these strategic initiatives in 2018. We struck a number of new strategic partnerships which started in the fourth quarter of 2017 with TD Ameritrade, and continued through 2018 with Cetera, Ally, E*Trade, Orange, and Interactive Brokers. We believe we have done more strategic deals than any other ETF manager last year, and the pipeline looks strong for 2019. It is significantly easier for advisors and clients to do business with us now than at any point in WisdomTree’s history.
Also, a significant component of executing our distribution goals revolves around data intelligence. As you know, we partnered with IBM Watson, which has led to meaningful changes in how we operate the sales organization. This has already led to efficiencies across distribution and marketing while enhancing our effectiveness overall.
Finally, we launched our advisor solutions program in late 2017 with the objective of building better and deeper client relationships, which act as a catalyst to drive more consistent and more diversified flow. In the past 12 months that this program has been in the market, the feedback has been exceptional. We have already seen meaningful increases in advisor wallet share at those firms that have adopted our solutions program. This may be the most significant greenshoot or initiative we have undertaken at WisdomTree, one whose potential is greatest to drive consistent accelerated organic growth in the future. As you can see on Slide 11, net flows and organic growth excluding DXJ and HEDJ have been strong and accelerating.
In the fourth quarter ex-the two funds, we generated 17% annualized organic growth across the global platform driven by a combination of domestic fixed income, domestic equities, and commodities. While it’s only been one month, trends in Q1 are impressive and we are hopefully setting up for the type of growth we know is possible from our platform. Given their current AUM levels, simple math would suggest DXJ and HEDJ outflows should slow in 2019, and we expect strong growth from the remainder of the platform. We know we have the right strategy and are positioned on the right side of the secular trends and are beginning to see the impact of the significant investments we made over the past few years. It’s been a challenging few years, but I believe we’ve crossed an important inflection point with the business and are poised for the next wave of growth.
Thank you for your interest in WisdomTree, and we’ll now open it up to questions.
Our first question comes from the line of Dan Fannon with Jefferies. Your line is open.
Thanks, good morning. I guess, first, Jon, the comments around--I think it was $3 billion from the new distribution agreements that you’ve signed and a healthy backlog, I think, for new partners. Could you talk about where you are in the evolution of some of the newer ones, meaning was there initial step-up and then they kind of naturally mature, or should we see even the ones that you already have, like--I guess, where do you think you are in terms of the penetration of those relationships, and then also a little more color when you talk about the backlog of additional partners.
Thank you for your question. Kurt MacAlpine, our Global Head of Distribution, why don’t you take the first crack at the answer, please.
Sure, hey Dan. When we think about the timing around the impact of our distribution partnerships, there’s really two factors that matter. The first one is are the firms that we’re partnering with using ETFs today, and then do the advisors on the platform, are they aware and believe in our modern alpha approach to investing. If you think about partnerships, when we signed them with RA custodians and RA firms like a TD Ameritrade, for example, we typically see immediate impact. These firms are familiar with ETFs and they have advisors that are actively looking for differentiated strategies. By us removing the friction of doing business, we tend to see an immediate impact on our flows, and that impact has persisted since we’ve signed some of these deals.
When we’re signing partnerships with IBDs, retail platforms, bank brokerages and things like that, the time to execution is longer as we’re playing a much more active role in educating their advisors and clients on the benefits of ETFs over mutual funds, and then also educating them on the WisdomTree story overall. This doesn’t mean that the potential of these platforms is any lower - in many instances, they might actually be higher over the long term, it’s just the time to realize the impact is longer, given that education process and role that we need to play.
Now in terms of pipeline, I guess if you were just asking what does the pipeline look going forward, I think one of our advantages here is that we were very early from an industry perspective in getting out in the marketplace and having and shaping these conversations, and we are in the flow in a lot of different places, whether it’s RA space where we’ve done some deals, IBD space where we’ve done some deals, but also in new segments of the market as well.
Okay, thank you. Secondly on expenses, understand you’re flat with the second half run rate on the discretionary side. Can you talk about where you are spending for growth and maybe the flexibility - you know, assets have kind of rebounded here in January, but if we go the other way, how we should think about your expense structure in a less favorable environment?
Sure Dan, it’s Amit. Obviously a lot of our expenses can move around with AUM, but there are minimum cost levels that we have of just operating the business, and that’s why we’ve given some of the updated guidance. I’d say we always look for ways to bring more efficiencies into the business. We did find ways currently to recycle some of those efficiencies so that we can continue to make investments, but we’ve proven in the past that, look, if we do see some prolonged downturn, we can take down some of our discretionary spending around marketing and sales. We will see leverage, you know, downside in compensation when we do see declines in AUM, so there is flexibility that we have. We’ve proven in the past that we can manage that expense base if we do see declines in the revenues.
Okay, thank you.
Thank you. Our next question comes from the line of Bill Katz with Citigroup. Your line is open.
Okay, thank you very much for taking the question. Just staying on the guidance for a moment, could you walk us through maybe the upside-downside scenarios that you talked about, Jon or Amit, just in terms of the low versus the high end. What are some of the underlying key metrics we should be looking at when we consider that range?
For any particular line item, Bill, or just--
Well, just I think the big deltas would be the comp, right, so let’s just talk about maybe the U.S. comp side, perhaps.
Yes, so we’ve given a range this time to hopefully make it a little bit easier for everyone to model that. Obviously incentive comp is the biggest component of that, and there’s various factors that go into that. Our incentive plan is built 50% of us meeting certain financial and operating metrics, and 50% of it is discretionary, so we don’t disclose what exactly those targets are but maybe to help you think about it, if you look at street consensus today, our global inflow target that’s out there is about $2.7 billion of AUM. I would say that would probably get you something in the middle of the range of the guidance that we gave, if you just wanted to have a guidepost to work off of.
Okay, that’s helpful. Just staying on that theme for a moment, you’ve been retooling the business for a bit of time, and certainly appreciate the volatility of markets as well as the parabolic rise and decline in HEDJ and DXJ. Is there a point where the investment spending spigot starts actually to turn off a little bit so you can drive the organic growth, drive the operating leverage a little bit better here, because it feels like it’s a story that’s been coming for a bit of time now and this guidance looks about 20% below the street. I’m just trying to sense where is that inflection from a financial perspective that follows the flow pick-up?
Bill, you’ve followed us for a very long time. You know we’ve made a lot of investments over the last several years to help build out our distribution capabilities, our product set, building out our geographies, our technologies, our data capabilities. We’ve been taking down that spending or those investments over the last several years because we’re starting to see the benefits from that. Over the last two years or so, you’ve only seen the expense side of that business, and now we’re starting to see the revenue parts of those investments coming in.
You can see from the guidance that we’ve given that we’re holding our expenses, that discretionary spending, flat because we are starting to see the benefits from that, so now we can--as the AUM starts to scale, we can now start to drive up those operating margins.
Just one last one - thanks for taking these, I’m sorry to beat this same theme a little bit on the questions. If you continue to enhance your distribution and the product mix where it is, how do you think about the interplay between growth versus fee rates and incremental margin on that?
If we’re talking about the pricing of funds, I think we were really one of the strongest in terms of how we price our funds. The key to fees for ETFs is each fund has to be competitive within its space, and so some of what it is, is just mix. We had a very volatile risk-off environment, floating rate treasuries was a very strong asset gatherer at 15 basis points. Not discounting the exposure, we’re priced at the same price as the other competitor in the space, but that’s just a mix that we’re dealing with.
We do believe that some of the strategies can generate faster growth, things like solutions, but that it’s very--you know, you touched on it at the very beginning of your question, about DXJ and HEDJ, it’s been--they were parabolic up, they were extraordinarily painful on the way down, and it’s very difficult to show net-net growth and margin against that backdrop and then couple it in 2018 with about $8 billion of negative market move for the year. As you who follow the industry, and all of you follow the industry, it’s very challenging.
What’s positive for us is the organic growth rates are starting to break through DXJ and HEDJ and maybe those will turn positive, but at a minimum we’re hopeful that we have now gotten scale on enough other things, whether it’s fixed income or commodities or global equities away from currency hedging, that we can overcome those from a flow perspective. But I don’t think--you know, when we launch new funds, newer vintages of funds have been very price competitive, and if you go dig deep into Amit’s first page about where the flows were happening, we were seeing flows both in things like emerging markets, in original emerging market funds like DDM as well as newer funds at different price points, like [indiscernible] Enterprises. We’re very, very comfortable with the balance that we have on pricing, and again we highlighted this last call, fees are very important for sure, but after fee performance is equally important or more important, particularly as you’re bringing new advisors into ETFs who have historically been selling active mutual funds. It’s really resonating, the full solutions program with the modern alpha spin, so we’re very happy with the way we’re pricing and we think we can grow faster if market sentiment is constructive.
The only other element, since we’re an all-ETF shop, ETFs globally in 2018 were down about 40% from a flow perspective, so it was a challenging backdrop in every way.
Okay, thank you for taking all the questions this morning.
Thank you. Our next question comes from the line of Robert Lee with KBW. Your line is open.
Great, good morning. Thanks for taking my questions. My question is on flows and maybe looking at them in a different way. Clearly fourth quarter, you guys did well considering what was going on in the industry and getting off to a good start this year, but beyond net flows, can you maybe--if we were to try to think of the revenue contribution of those flows, would it be similar to the flow impact on AUM, or is there a meaningful difference? Can you maybe give us some color on how that’s been trending?
We have seen flows coming in, in a mix - on our gold products, USFR was particularly strong more recently, so because of that mix change that we’re seeing, you see that affecting the gross margin coming down slightly, as well as the cost of just some additional fund launches getting into the cost base as well and just waiting for them to scale. You do see that in the average revenue capture, the fact that more flows are coming into some of our lower priced funds.
Okay, and maybe following up on the distribution deals, obviously a lot going on. It’s a very U.S. focus, understandably, but can you maybe talk about similar things that you maybe have in the works or you’re thinking about as your European business has started to scale?
Yes, it’s Kurt MacAlpine here again. I would say that the approach to the distribution deals is definitely global, that we’re thinking about it as, once again, the theme around opportunities to get closer to our clients and reduce the friction of them doing business with us. In addition to a big focus, and you’ve seen and heard a lot about us in the U.S., we do have distribution deals in place in a number of different markets, albeit smaller in nature at this point. We do have commission-free deals available in Japan, we have strategic deals in Canada. We were just announced this year to be Samsung’s ETF model manager in South Korea, which has a distribution component to it, and we have a distribution model arrangement in Italy as well. I would say similar to the U.S., it’s a big focus for us, there’s more to come, and I think you’ll see more from us both in the U.S. and internationally over the next months and years.
One last question, I appreciate your patience. This is around capital management. Thinking about not exercising the AdvisorEngine option in the fourth quarter, given what was going on it was understandable, but considering that a while back you reduced the dividend and talked about wanting to maximize capital flexibility for strategic opportunities, and certainly the fourth quarter highlighted the potential operating leverage, negative operating leverage in the business and the industry. Is that at all shifting how you’re thinking about your capital usage going forward? Is even the modest $0.03 dividend the right level? Any change, just given what you went through in the fourth quarter?
I would say, look - you know we’re conservative when we think about how we best deploy our capital, and I’d say we try to balance between making sure we have the right amount of capital to focus on growth and strategic opportunities, making sure that we do the right thing to return excess back to our shareholders through dividends and buybacks, and we also have the debt that we took down as part of the ETF Securities transaction. I think if we see some more stability in the markets, we will think about how best to redeploy that capital or change the shifting of the balance of what’s our priority, but right now we’re kind of happy with the current mix that we have in place.
Great, thanks for taking my questions.
Thank you. Our next question comes from the line of Michael Cyprys with Morgan Stanley. Your line is open.
Good morning. Just following up on the AdvisorEngine, the expiration of the option there, can you just talk about that a bit more? How much would that have cost you to exercise, how much incremental ownership would that have given you, and if you could talk about what’s remaining, any sort of options left that you have, and if it was compelling, which I guess is what you guys were suggesting on prior calls, why not just go ahead and exercise it?
Sure Michael. We’re not going to disclose, unfortunately, a lot of what you asked, but I would just say, look - we have a very good relationship with AdvisorEngine. As I said in my prepared remarks, given the market backdrop, we decided not to exercise the option. The option was to buy all the remaining stakes, that we would own 100% of AdvisorEngine. I would say if we do see an improvement in the business environment, if we do believe that we would have accelerated growth after owning 100% of them, and if we think it’s the best way to maximize value to our shareholders, it’s something that we would look at in the future. But we’re very happy with the current relationship and our existing shareholder interest in AdvisorEngine.
This is Jon. I’d just add to it, we’re happy with the way we structured this from the beginning, so we’ve been able--AdvisorEngine, an early stage business had losses, had losses. We’ve been able to keep those losses off of our income statement while they have been developing out their business, as well as allowing us to integrate them as a part of our solutions program, so it’s actually been a very positive structured deal for us which gives us a lot of flexibility. As Amit said at the beginning, we are their largest shareholders, we have strong shareholder rights, so we’ll be able to make the most of this going forward, we believe.
To your point on AdvisorEngine making those investments there and trajectory, can you just give a little bit of color on the trajectory of losses and your updated thoughts around when that would turn from a loss to a profit position, the pacing of those investments? Just any sort of color, any sort of metrics you can share around the AdvisorEngine business?
The only thing that we’ve said in the past, and I’ll reiterate it, maximum losses would have been, we believe, for their business in 2018.
Okay, and if I could just throw in maybe a separate follow-up question, just on the product development side, if you could just share your expectations there for new product launches in 2019, how many new product launches should we be expecting, and where do you see the white space today?
What we don’t want to do is telegraph anything that hasn’t been filed. The industry is incredibly competitive. I think you’ll continue to see--first of all, we have to think of product launches on a global basis now, and we’re very much trying to coordinate what we’re doing globally and if it’s possible, to get IP to go all around the world. Things like our multifactor are starting to appear around the world, but I think--and on the other side, we’ve always tweaked fund closures as well, trying to squeeze out as much efficiency as possible. But I will say we saw--we were very excited with what we saw at the end of last year around some of the new product launches, and I think that we’re not seeing a shortage of constructive ideas to bring to the market. But I don’t think it will be an unusually large or small year, sort of just middle of the road versus prior years.
Great, thank you.
Thank you. Our next question comes from the line of Chris Shutler with William Blair. Your line is open.
Hi, good morning. Jon, as you think about where the industry is going, to what extent do you expect the big banks and brokers to ramp up their own product development efforts around proprietary smart beta funds?
I think that over the last number of years, you’ve seen lots of new entrants and people with proprietary distribution launch product, both a combination of beta and smart beta. I think it makes sense that they have done so, and I think that it will continue. Again, the structure continues to prove itself out. I would say the fourth quarter was very constructive for ETFs in general. When you think the capital gains that mutual funds delivered in the fourth quarter, it’s a good reminder to advisors that if they haven’t moved their business over to ETFs, it’s something that gets harder and harder for them to ignore. We think that it’s a great catalyst for future growth. Smart beta, modern alpha performed very well in the fourth quarter and in the year, and I expect WisdomTree’s approach to ETFs to really resonate on a going forward basis.
As we’re doing more fully transparent to active, I think we get more performance differentiation and more difficult for copies to come out in the market from competitors, so net-net the industry has evolved really the way that I thought it would evolve. It was always intense and it continues to be, but there’s really no surprises, I don’t believe.
Okay. On the fixed income ETFs, which you had a lot of success with last year, what’s been the largest channel contributing to those inflows?
It’s Kurt MacAlpine here again. It’s actually been a very nice mix across channels, so it’s coming from a combination of the YLS channel, the IBD channel, the RA channel as well, so it’s been pretty consistent across the channels, which is great to see. The other piece which I will mention is given the efforts that we’ve made around the data intelligence and building out those capabilities, the visibility that we have on who owns our strategies is really at an all-time high, so we have a very good understanding, to your question around who holds the strategies not only at the channel level but at the individual firm and advisor level, which is really helpful to our sales efforts but also our client servicing efforts.
Okay, good to hear. Lastly, the quarter-over-quarter increase in the sales and bus-dev expense, if you could talk about that and the higher spending on corporate consulting-related expenses, if you could just explain that. Thank you.
Yes, typically our sales and marketing expenses sort of slow down in third quarter. If you go back the last couple of years, you’ll see in the summer months we sort of--just to manage the cost base, we take that expense down, and in the fourth quarter that expense ramps up, so you do see a little bit of seasonality in that. On the corporate consulting, it was just closing out some open projects that were going on toward the end of the year.
All right, thanks Amit.
Thank you. Our next question comes from the line of Michael Carrier with Bank of America Merrill Lynch. Your line is open.
Great, thanks, and good morning. First question just on the competitive front, if you look at some of the distribution arrangements that you guys have in place, obviously it’s been driving healthy flows. The flipside is the third party distribution fees, those continue to ratchet up, so when you guys are looking at it and maybe how we should look at it, should it be on the revenue side a net revenue just as you continue to drive more of the business in those channels? How do you think of some of the net revenues or the economics relative to the past?
So like I’ve said, this opens up a new distribution channel for us, or it helps us, as Kurt said, reduce some of the friction of selling our ETFs. I mean, you can look at it as a net revenue concept, but it’s just another way for us to drive flows.
One other thing I wanted to add, if you think about--I guess if you’re looking at just the overall cost base, one of the greatest benefits of these partnerships is the access to data that they provide us with, so that data allows us to do two things. One is to identify and begin covering clients that we haven’t had a relationship with historically, so essentially expanding that overall pool of people, and then also better understanding who we have relationships with today and ultimately, hopefully, and I think we’ve demonstrated in proving our success rate with them.
One of the levers that we’re using to do that is a really strong and increased presence around digital selling and digital marketing, which obviously is a very cost-effective lever, so while you may see some shift on the top line sometimes, depending on the channel and the relationship, you do get a pick-up on the bottom line given how much we’re using digital, really tapping into the data that’s provided from these platforms.
And you would hope that these partnerships and platforms allow us to achieve just ultimately faster growth - I mean, that’s the belief as well.
Okay, thanks. Then Amit, just on the range of the compensation, you mentioned there are certain targets that you guys don’t disclose. Just wanted to get some sense, you mentioned the flows in terms of street expectations, maybe if you don’t want to give the exact targets, what are some of the things that we should be thinking about as the year progresses, whether it’s sales, whether it’s margin, just things that could direct that comp higher or lower.
Yes, so they’re the logical ones that you would think of that help drive our business and that are good for our shareholders. We look at things as market share, flows, our revenues, our margins, how our stock has performed versus the other publicly traded asset managers. Those are all the sort of types of metrics that we look at in determining compensation. Again, 50% of that is performance based and then 50% of it is discretionary, determined by our board.
Okay, thanks a lot.
Thank you. Our next question comes from the line of Brennan Hawken with UBS. Your line is open.
Good morning. Thanks for taking my question. A quick one on the pricing for the international hedged, currency hedged products. Have you considered taking a look at where your pricing is versus the substitute products that some of your competitors have launched, and at this point now that the AUM has declined to a point where it’s not nearly as impactful, have you thought about maybe adjusting the pricing so that you could be more competitive and perhaps draw in more flows or inflect the flow trends that we’ve seen as some of the lower priced competitors have gained share there?
This is Jon. DXJ still has about 72% market share against the other large players in the space in the currency hedged specific, and HEDJ actually saw its market share go up a few percentage points over the course of 2018. As the liquidity leader, the asset leader, sort of the brand leader in those spaces, I’m not feeling a lot of pressure to lower fees in any way. What we need to see is sentiment around--I mean for us, the big ones would be sentiment around Europe and Japan to improve, and we would see--we would expect to participate in any change in sentiment, a positive change in sentiment proportionally to our AUM.
Okay, that’s fair. Then separately, there’s certainly a bit of a struggle as far as scale goes. You guys have referenced improving the margins as your scale builds, but generally speaking it’s been increasingly clear that ETF business is a scale gain. What makes you confident that going it alone versus partnering with a competitor is the right and value maximizing proposition for shareholders?
First of all, we represent something like--we’re the sixth largest ETF sponsor in the world from a revenue standpoint, which is a real measure of scale. We’re in the largest markets around the world. I do believe, though, as I said earlier in my planned comments, it’s been a frustrating few years. The outflows in DXJ and HEDJ have masked lots of transitions and improvements to the business model. But when you look from an M&A standpoint, I think that we have something that is very valuable. You might think that these, in light of the way the asset management industry is trading in general, that this wouldn’t necessarily be a good time to consider anything from an M&A standpoint, but we are a fiduciary public company, we have to do the right thing. But as I sort of ended the presentation, I think if we can achieve the best-in-class organic growth of the publicly traded asset manager, we can get back to being one of the better performing publicly traded asset managers. I think the two will go hand-in-hand, and I think with higher AUM, and we’re thrilled with what’s taken place in January versus Q4, margins will come back as well.
Thanks for the color.
Thank you. Our next question comes from the line of Max Sykes with Gabelli. Your line is open.
Good morning everyone. On this U.S. floating rate ETF, can you parse out some of the flow action this quarter, whether it was share gains from typical money market funds or more related to de-risking from the market, and then how we should think about growth going forward?
Hi, this is Jeremy Schwartz, our Global Head of Research. USFR is competing really as a core defensive fixed income division, so Jon talked about the volatility in equities and USFR, if you just look at its performance across time, it’s a very steady position. It competes with a few different bond categories, from the shortest term government bond fund to short-term credit funds, to even bank loans, that people are using to manage duration traditionally just with the credit [indiscernible] on top of it. So what you saw with some of these other traditional, more credit-oriented instruments in Q4, people have been trying to manage duration with them but there was big sell-off in, whether it’s bank loans or even the more LIBOR type floating rate funds, and when you think about just the risk-return trade-off today, how much risk you’re taking on in the traditional bond indexes, where duration keeps extending and you have the longest duration for the ag in a long time, and then you have no real compensation for that duration, so the spread to go the 10-year bond versus the 240 you get essentially in Fed funds and in USFR, we’re seeing a lot of resonance of just taking less risk, whether interest rate risk or credit risk, and so as a core short term bond fund, we think it’s a really good exposure for the short term and the long term.
Then my last question would be around this IBM Watson relationship. Can you talk--maybe parse out one example of where it could lead to enhanced productivity? Just wanted to understand a little more about the relationship.
Sure, absolutely. What IBM Watson has done for us is we, on our own - I’ve talked about this a little bit in the past, where we’ve created one integrated database that capture everything we know about clients, so all of our sales data, all of our marketing data, all of our asset data and all of our flow data. Essentially, what IBM Watson does for us is they run a predictive algorithm on top of that, including all of the demographic information that they have on these underlying people.
I’ll give you two quick tangible examples. How our sales team thinks about their territory management and their client list construction is informed by the insights that are generated by IBM Watson. That’s one area where people are thinking about structuring and spending their time with clients that have the highest propensity of positioning to do business with us. Another area, as I mentioned a little bit earlier today, one of the great values of these strategic partnerships is the data that comes along with them, so when we receive that data on these firms and advisors from our strategic partnerships, it goes into our IBM Watson algorithm and gives us a very good sense for who are candidates that are likely to do business with us in the short term, and that allows us to either sell to them or market to them in a much more targeted and segmented way.
Are those details helpful enough?
Yes, thank you very much.
Thank you. Our next question comes from Keith Housum with Northcoast Research. Your line is open.
Good morning. Amit, looking on the international segment a little more, can you provide a little bit more color on the gross margin decline and the timing of the certain expenses? I’m just trying to understand how that works with the guidance for next year of 70% to 72%.
Yes, so we had some higher expenses in the fourth quarter than we had anticipated. To be honest, it’s part of the ETF Securities transaction, trying to get the accrual-based accounting all sort of lined up, so we had some timing differences of when the expenses came in and that was predominantly what caused the higher expenses in the fourth quarter. We think that’s all going to get normalized and that’s why you see that sort of ramping back up to that normalized 70%, 72% level going forward.
Okay. I can appreciate that fourth quarter had some good inflows, but I think the total funds are still a little bit less than when you guys agreed to acquire the company, the ETF acquisition. But also, your margins have come down. Is there any chance or any concern that you may have an impairment with that acquisition?
Don’t know what’s going to happen in the future, but no, we feel very comfortable where we sit today that that’s not going to be an issue.
And just one small nuance, since the close of the acquisition, actually assets are up and inflows are positive.
Okay, great. Thank you.
Thank you. I’m showing no further questions at this time. I would now like to turn the call back to Jonathan Steinberg, CEO of WisdomTree for closing remarks.
Just want to thank you all for your interest in WisdomTree and we’ll speak to you again next quarter. Thank you, have a good day.
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone have a great day.