WETF Update: Winter (Vanguard) is Coming!

Just a quick post to record my thoughts for future evaluation.  I purchased WisdomTree (WETF) earlier this year for ~$9 per share.  I am going to sell 2/3 of the position @ ~$12 and just let the 33% profit run (in a tax deferred account, or I would not bother).  The basic evaluation when I bought was that I liked the business, insiders/founders are in control (reducing principal-agent conflicts), and it was trading with an enterprise value of around 2% of AUM.  

Why did I like the bidness?  First, the gross margins, ROIC and other metrics are fantastic (some of the figures are depressed by stock compensation/dilution but one has to allow for that in a fancy growth business). They own their indexes for the most part (as opposed to paying S&P or MSCI for the use of intellectual property). The growth in many of their funds was being obscured by the outflows from DXJ; their massive Japanese Yen hedged ETF.  I concluded this is transitory or cyclical. I like the dividend weighting methodology (although I would prefer shareholder yield, to include buybacks).  I think it will provide the advertised value tilt and very low turnover.

I also think the potential behavioral benefits of the dividend weighting are perhaps under appreciated.  First, the very diversified indexes are likely to have low tracking error, so it will limit the temptation to performance chase and (sell low and buy high).  I also believe the dividends will serve to calm fears during market selloffs.  Many of the WETF funds also pay dividends monthly, which may help to focus investors on that figure (as they receive checks) versus the wildly vacillating reported earnings (or even more wild market quotations).  In sum, I liked the bidness.

When I bought the shares I figured ~3% was a more reasonable middling value for WETF.  Guggenheim Securities recently sold their ETF business to Invesco for a little over 3% of AUM (including debt assumed).  This was a fantastic comparable in my opinion as the AUM of Guggenheim was almost equal to WETF and the average ERs on the funds were highly comparable too.  So I felt good about my margin of safety, getting a growth bidness with nice returns for a 50% discount to a very recent, very similar comparable, arms-length transaction.

So what changed?  First, WETF has agreed to acquire a European ETF business focused on commodity funds for > 3% ev/aum.  I don’t like commodity ETFs as I think more and more research is showing their don’t provide the desired hedge due to the costs of rolling futures and other problems.  Also, there is an argument that base commodities are in a secular deflationary spiral as we become more technologically advanced.

I think the responses to these concerns could be that they are buying funds which will likely do nicely as far as gathering assets if we experience inflation.  For example, if the backlash against Trump ends up with a very left of center administration (and similar reactions to the far right around the world) one could envision a return to like a strong labor movement 1970’s environment.  Basically, the lack of inflation may eventually result in the resurgence due to underinvestment or political backlash…whatever black swan you want to conjure up.  So if that happens, they are buying cheap (because the AUM would swell).

In the end I don’t like the sort of “throwing stuff against the wall” to see what sticks.  I liked the value/behavioral aspects of the dividend weighting (and the quality-tilt suite); but adding a bunch of this other stuff is diluting that identity/brand in my eyes. I also generally has a strong aversion to acquisitions.  They very often disappoint.  I would prefer organic growth.  WETF should have plenty of green grass to grown without paying +3% of AUM.

They have been investing a lot in technology solutions to enable advisors to employ “robo” tools; e.g., ThinkAdvisor.  I think this is a big opportunity for them to grow as the whole industry is undergoing massive change.

Finally, Winter (Vanguard) is coming!  I noted in my post on foreign value ETFs, Vanguard is launching (active) factor funds in the U.S. next year.  I reviewed their application and the algorithms proposed to be used are not disclosed so I would not consider them as options at this time.  If they are coming for “Smart Beta,” however, the business just got materially worse.

So, I’m going to take my initial investment off the table and let the profits run.  Like most of use, I often sell winners and let losers languish.  There are behavioral reasons we all tend to do this.  So in this case I’m going to at least stay 1/3 long.  I am also aware of the potential for WETF’s announced acquisition to prompt a potential buyer lurking in the weeds to come in with an answer to acquire WETF (before they can muck of the works).  Yet, another reason to sit still/move slowly.