WisdomTree, Inc. Q2 FY2022 Earnings Call

Good day, and thank you for standing by. Welcome to the WisdomTree Q2 Earnings Conference Call. Please be advised that today's conference is being recorded.

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 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 the WisdomTree annual report on Form 10-K for the year ended December 31, 2021, as amended. WisdomTree assumes no duty and does not undertake to update any forward-looking statements. Now it is my pleasure to turn the call over to WisdomTree CFO, Bryan Edmiston.

Thank you, Jessica, and welcome, everyone. I'm going to start by reviewing the results of the second quarter, and we'll then turn the call over to Jarrett and Jono for additional updates on our business. We have been operating in a market environment with heightened volatility as broad-based equities declined about 15% this quarter. Despite the overall volatility, we achieved $4 billion of inflows this quarter, our strongest flowing quarter since 2015, and our AUM is well positioned as over two-thirds of our offerings are tethered to current themes such as rising rates, inflation, and value rotation. Accordingly, our AUM at June 30 was $74.3 billion, down only 6% during the quarter. Negative market movement was partly offset by our inflows with our floating rate treasury product, USFR, performing as a safe haven during these challenging times. Our growth story is a success. Our annualized organic growth rate is about 13%, and the story isn't only about USFR. We continue to demonstrate sustained momentum, having generated positive inflows for seven consecutive quarters across many asset categories, including U.S. equities, emerging markets, international equities as well as fixed income. The breadth of our product line has us well-positioned to navigate the volatility we are seeing today. Our AUM currently stands at $74.3 billion, unchanged from the end of the quarter, as flows of over $400 million in July have been offset by negative market movement. We are focused on controlling our costs in the wake of the market turbulence, and I will circle back on updated expense guidance in a moment. Next slide. Revenues were $77.3 million, a decrease of 1% from the prior quarter due to a 1 basis point decline in our average advisory fee. Adjusted net income was $11.3 million or $0.07 a share. Our non-GAAP results, excluding a noncash after-tax gain of $2.3 million for our future gold commitment payments, and $4 million in other net nonoperating losses. Our adjusted net income also excludes $2 million of expenses incurred in response to an activist campaign. We do not anticipate incurring any significant activist campaign expenses during the remainder of this year. Next slide. Our adjusted operating expenses were up 2% for the quarter. We experienced higher fund costs due to recent product launches and sales-related expenses were up as well. These increases were offset by lower third-party distribution expenses as market volatility has suppressed AUM growth on our Latin American platform. Next slide. Now circling back to our forecasted expense guidance. In the prior quarter, we communicated that compensation was anticipated to migrate toward the high end of our guidance range given our strong organic growth. While our growth persists, we are tightening our guidance and reducing the high end of our range by $3 million as we temper hiring plans in the wake of uncertain market conditions. Our compensation guidance is now $96 million to $99 million. We had previously communicated discretionary spending guidance ranging from $49 million to $57 million. This spend has been well managed to date, warranting a reduction in the high end of our range. Our discretionary spending guidance is now $51 million to $53 million. Our digital asset spend, which is included in our compensation and discretionary spending guidance, now ranges from $11 million to $12 million. Previously, we communicated a range of $9 million to $14 million. This quarter, we reported a gross margin of 79%, a 1% decline due to recent fund launches and higher transaction-related fees. At current AUM and flow levels, we would anticipate a gross margin of approximately 79% for the year. We are reducing our contractual gold payment guidance by $1 million to between $17 million and $18 million given recent declines in the price of gold. As a reminder, this expense is based on us paying 9,500 ounces of gold on an annual basis and is measured based on monthly average gold prices. Estimated third-party distribution fees are being revised downward by $1 million to approximately $8.5 million given the impact of market volatility on the AUM on our platforms. And our tax rate remains unchanged at 21% to 22%. That's all I have. I will now turn the call over to Jarrett.

Thanks, Bryan. For those who have participated in WisdomTree calls over the past couple of years, you've heard me outline our perpetual focus on growth, both today's growth and tomorrow's on efficiency and on team. We feel if we take care of these items, the results take care of themselves. Another constant theme, which is especially relevant in difficult markets, is to control what we can and to execute our plan and deliver results. In terms of today's growth, despite a very challenging market environment, WisdomTree has executed against plan and delivered another impressive quarter generating nearly $4 billion of quarterly inflows, bringing year-to-date net inflows to $5.7 billion and delivering a best-in-class 13% annualized organic growth rate. And today's organic growth isn't a sudden development. It's been building and growing for several years, while tomorrow's growth will be driven by a combination of sustaining our current momentum and adding to it our digital assets growth initiatives. In terms of sustaining current momentum, our product performance and positioning remains incredibly strong with 82% of our U.S. AUM beating Morningstar benchmarks, and most of our global AUM levered to themes like inflation hedging, increasing rates, and the rotation to value. Our AUM has never been so well diversified, and product performance and positioning has yielded breadth and depth of flows across our entire global product suite. Additionally, we also continue to execute on our managed models vision, and this focus continues to deliver. Our strategy remains two-pronged. First, we are focused on partner platforms such as Merrill Lynch, Morgan Stanley, and others. And second, we are focused on RIAs in the independent broker space, strengthened by our recent launch of the WisdomTree Portfolio and Growth Solutions platform. The beauty of the models business is that once you win adviser mind share, flows are recurring in nature and stackable on top of our current inflow profile. We remain excited about the trajectory of our models franchise and see a long growth runway ahead. We are also executing and delivering on our digital assets vision. As we have discussed before, our straightforward vision is to bring crypto exposures mainstream through ETPs and separately managed accounts while also bringing mainstream financial assets into the digital ecosystem through blockchain-enabled funds and assets. Jono will talk more about this in a moment, but our approach has been disciplined and measured and designed to leverage the core competencies and efficiencies of our core ETF business. It is exciting to see our steady march towards rollout on schedule and at hand. As important as growth is operational efficiency, we have built an ETF business that is extremely scalable and delivers robust incremental margins. Over the past several years, we've made many operational improvements and now have incremental margins well over 50%. This means as markets normalize and we continue to execute on our growth strategy that we will be able to do it on expanding margins with a vision and goal of having best-in-class operating margins as we scale higher. Finally, we have the best and most productive team in the industry. Our sales team outperforms our competition as evidenced by our best-in-class organic growth. Our overall AUM and revenue per employee is well above industry average. Meanwhile, our employee satisfaction is high and our employee attrition is low. The benefits to us are large, and the cost of those in the industry with lesser performance is high. We believe these results are due to our clearly communicated vision and the satisfaction the team takes in executing well and delivering results. All in all, our focus on growth, efficiency, and team is paying off. We are executing and delivering outstanding results in all areas under our control, with strong sustainable growth today, coupled with momentum in digital assets initiatives to drive future growth, all on top of scalable infrastructure driving exciting incremental margins. We remain enthusiastic and optimistic about the future. With that, let me now turn it over to Jono.

Thank you, Jarrett. We are in the business of providing the best structured transparent products. Today, that is ETFs, where we have a very successful business, and I'm really pleased with how well WisdomTree's core ETF franchise is performing in the face of a seriously tough macro environment. We are seeing strong organic growth, one of the very few in the industry. Engagement with our clients remains incredibly high, and we have product positioning and flow momentum that gives us confidence in sustainable growth. Our digital asset approach, as Jarrett mentioned, has been disciplined and focused on leveraging all of the efficiencies that the core ETF franchise provides. We have 250 employees at WisdomTree, and the hard work of each of them is relevant and transferable to bringing asset management onto the blockchain. Tokenization will be the structured and transparent products of tomorrow, making it a natural evolution of our business model. While others stiff-arm the regulators, we knew our deep regulatory knowledge was and still is a key early advantage to future success. Our advantages are our knowledge and experience in regulated transparent exposures. Before this crypto winter, there was pressure to keep up with high-flying new entrants with robust funding, Super Bowl ads, and too good to be true offerings. The landscape has changed dramatically. Money isn't free. While some companies have struggled with the realities of regulation and risk management, and other companies have lost the trust of their customers and investors completely, for WisdomTree, the timing of this crypto winter is very constructive and brings lots of opportunity. Our trusted brand and responsible DeFi approach to digital assets is serving us well. Frankly, we are better positioned to navigate these challenging markets than many, and it is exciting to see our rollout plans coming to fruition. WisdomTree Prime is live in the initial phases of beta testing. Since our last update, we've minted a dollar token, and minting our gold token is imminent. Key early products are on our roadmap. We are building in a disciplined and measured manner, and we will roll out to more states and users in future months as we enhance our third-party distribution capabilities with these digital asset products and services. Our focus on continuously innovating the products and adding new features will distinguish us in the marketplace and help drive future growth. This is the roadmap: start with a unique and curated client experience, then iterate and evolve the platform, launch new products and functionality, all to unify spending, savings, and investing. Call it a consumer finance super app, a digital wallet, or its own unique thing — the end goal is to deliver financial services to customers faster, cheaper, and with better outcomes than exist today. Simply put, our digital asset strategy is on track. We will continue to leverage the efficiencies of having an established and well-managed ETF franchise, setting the table to start seeing top-line revenue from digital assets in 2023 without a significant uptick in costs for steady, disciplined, and responsible growth that sees a massive runway ahead for WisdomTree. Thank you. Now let's open the call to questions.

All right, everybody. This is Jeremy Campbell, Head of Investor Relations, over here at WisdomTree. Similar to prior quarters, we are going to kick off the Q&A session with some questions from our retail shareholders via the Say platform. So question one is some of your EM products have had exposure to Russian securities in the past. What, if anything, has WisdomTree done to mitigate these risks? And is Russian security still a significant portion of the emerging market portfolios?

Great. Thank you. Emerging markets is a real strength for WisdomTree. We have three broad-based and diversified emerging market ETFs with real scale, two of which now have 15-year anniversaries this year and approximately $6.5 billion of AUM split between these three diversified ETFs. The short answer is Russian securities have been marked to zero across this lineup. So there's really no further downside risk to the NAV of ETF shareholders. And the real question going forward is how do you manage the upside? Is there upside in these securities at any point in the future? For WisdomTree, this is a real competitive advantage of being a self-indexing firm. What you've seen across the industry has been index providers kicking out Russia from the indexes due to a lot of political pressure. If you think about trying to recapture value if these securities ever have value, it's perhaps not best to sell the very first day you can. So we're going to try to navigate that to capture value over time. And again, that's a real competitive advantage for our self-indexing approach. Just a quick comment on performance because the main story this year has been a large value rotation, and Russian securities did look like they were value stocks at the start of the year. They had high dividends, low PE ratios. We do have a strong presence of high-dividend ETFs, one of those original 15-year anniversaries. Despite being overweight Russia compared to the market, our high-dividend EM ETF is still a top-performing emerging market fund according to Morningstar, both year-to-date and the last year. It's attracted over $250 million of inflows, showing how much the value rotation is driving performance. The small-cap ETF, DGS, which I believe is the largest small-cap ETF globally by AUM, is also a top decile performer this year and the last year. It's coming up on 15 years of history later this year and has also taken in $350 million year-to-date. While growth is underperforming, our core ex-state-owned franchise still has a very good long-run track record with about $2.5 billion of assets there. Still, we have long-run good performance in the top three deciles, providing a solid foundation to build on if growth returns in emerging markets. But just summarizing, there's no further downside risk to Russia from NAV, only upside. We have a very strong franchise of emerging market ETFs for this very challenging environment.

Thank you, Jeremy. Jeremy Campbell, next question?

Yes. The second question is why is WisdomTree so committed to digital assets? What growth are you anticipating in this space? And do you think RIAs and FAs will put client assets into digital assets in the coming years?

Thank you for the question, Jeremy. I'll start by addressing it. Will Peck, our Head of Digital Assets, is also on the call, and if I miss anything, he can certainly add to it. This is a very important question for WisdomTree. As Jarrett mentioned earlier, our vision for digital assets is essentially twofold: first, we aim to bring cryptocurrencies like Bitcoin and Ethereum to Main Street, and second, we want to transition traditional assets onto the blockchain, such as gold or treasuries. Currently, we are bringing crypto to Main Street in Europe through ETPs and in the U.S. via direct indexing. Although it's still early days, there's significant opportunity here. We recognize strong interest from end clients, and the U.S. wealth management sector alone represents a $30 trillion AUM opportunity. Even a small allocation presents a considerable chance for growth, and WisdomTree’s trusted brand positions us well to assist financial advisors and registered investment advisors in helping their clients invest in crypto safely and compliantly. Regarding our vision of bringing traditional assets onto the blockchain, we believe that all financial assets will eventually adopt blockchain infrastructure, which serves as a highly efficient, transparent platform for the future. This means faster settlement times, increased automation, and thus quicker, more cost-effective customization. Communications with customers will be instantaneous and almost free, and the global nature of blockchain will enhance our offerings. These advantages indicate why we believe assets will transition to this new structure. WisdomTree is strategically positioned for this shift due to our strong product development capabilities, compliance expertise, and our incorporation of RegTech into our offerings. Our disciplined marketing approach and reputable brand should facilitate our success in this area. Ultimately, we view digital assets as a natural extension of our core ETF business. We foresee substantial opportunities for revenue growth in this segment as savings, investing, and payments converge onto new infrastructures. We expect to begin generating revenue from our digital assets business in 2023, all while keeping costs in check. That concludes my response.

And Jono, just stepping in. The only thing I'd add is, I'm glad we started when we did. I mean, we're certainly seeing over the past few months, a large tick in some of our traditional asset management competitors investing in this space, whether making minority investments in different startups or doing some of their own initiatives. So I feel like it was good that we got ahead of it when we did a couple of years ago.

Thank you, Will. Jeremy, next question?

Operator, you can now open up the call to questions from our analyst community.

And our first question will come from Rit Roy of Jefferies.

So the crypto winter has been tough to say the least, and we can kind of see that in your end-of-period marks for the asset class. But you guys did allude to the current opportunity set as being attractive given your business mix, and you have managed to avoid outflows, albeit marginally. Could you point to any specific products or maybe marketing efforts that have been effective in keeping this investor capital on the platform? Or maybe is it more of a function of the pace of product launches being a nation sort of platform for you guys?

Yes, sure. I think anyone who's been looking at crypto for a few years now shouldn't be surprised by this kind of volatility, right? It's not the first time that you've seen a downturn like this even in the past three to four years. So I think you can kind of break down the term crypto winter into three different categories. One is there's definitely been a slowdown in VC funding and hiring. You see that with firms like Coinbase needing to lay off people and other things going on. For WisdomTree, that's definitely been an advantage. It's a great advantage for recruiting, and it's a great advantage in terms of competition. So we view that as definitely a positive for us. The second is the actual asset prices themselves. Some of this was compounded by things moving down, frankly, because of the entire market—all asset classes beyond crypto were moving down—which was compounded by some crypto-specific issues where the failed projects and some other firms had core risk management issues that amplified the event. For us, and for our client set, it's actually a great opportunity. We've actually picked up market share in Europe for our crypto ETPs as some of our competitors in the retail-focused space have lost a lot of assets in this time frame. For our clients, they see it as a good entry point opportunity. We're continuing to have great conversations there. We see that both in the U.S. and in Europe. The third aspect is related to the previous one, which is that many firms broke trust. I don't need to name specific firms, but whether it was through just uncollateralized loans to a hedge fund or doing things with customer money that people just didn't really understand. With these bankruptcies and client losses, I think a lot of people don't trust their counterparts in the crypto space the same way anymore. So I think coming to it from WisdomTree with a great brand reputation and culture of risk management regulation, we're going to be well served to pick up a lot of customers in that space—both in the ETPs, indexes, and in WisdomTree Prime, which will be coming out soon. So for us, it actually extends across all those areas.

Thank you, Will. Jeremy, next question?

Our next question will come from Michael Brown of KBW.

This is Eden Hall filling in for Michael Brown. I was wondering if you could discuss the models business in more detail. Specifically, could you explain the differences in strategy between the large wirehouse partner platforms and the smaller RIA independent broker space? That would be great.

Sure. Great question. Jarrett, do you mind starting?

Sure. And it's a great question. And it's an important part of today's growth, but also tomorrow's growth. We're seeing already models contributing to the breadth and depth and to the organic growth rate that we've seen so far this year. The momentum of the models business is giving us a lot of confidence in that organic growth continuing. To address your question about the strategies, we have a two-pronged approach. One is the larger platforms like Merrill and Morgan Stanley. In those cases, you're getting onto the managed model platforms, which can be a challenge. First, you have to win the contest of getting on the platform, which can take a year or more. Once you're on the platform, the second victory you need to achieve is to gain adviser mind share. And that's really where hand-to-hand combat comes into play. You have the door opened by the house, but then you've got to go in and get the mind share from the individual advisers. This process can typically take over a year to achieve initial victories, followed by another year to gain traction. We're now over a year, almost two years with Merrill Lynch, and we're seeing great traction growing in momentum. This is a great piece of business, and once you've won the mind share, it becomes an annuity. Another aspect of the models business is that it's a multi-ticker victory. Typically in selling ETFs, convincing an adviser that one of our products is advantageous is a single-ticker victory. In contrast, with a model, it's a multiple-ticker victory that compounds on itself. We're continuing to see more penetration there, not only with additional partners but also with additional models with existing partners, so everything is moving very well there. The second prong is targeting the RIAs and IBDs. The strategy here is slightly different. With wirehouses, you've got an operational infrastructure that is quick to implement. If you're an adviser at a wirehouse and you like one of our models, it's all set up for you operationally, and you can click to implement. In the RIA and IBD community, however, there are many things that don't exist. First, the models themselves may require customization, which could be part our intellectual property or could be all theirs. But then the next critical factor is creating an easy button that advisers can click to implement models, which serves as a significant impediment for many RIAs and IBDs entering the models market. We just launched our portfolio and growth solutions platform towards the end of April and already have a strong pipeline, with new additions occurring weekly. We've already had a few wins in that category after such a recent launch, contributing to the momentum we've got in our business and our best-in-class organic growth.

Thank you, Jarrett. Jeremy Schwartz, could you add a little bit about our relationship with Professor Jeremy Siegel and how he adds to our mindshare and our ability to win business? Could you mind talking about his involvement in models?

Yes, I would love to. This has been a year where you've had challenges to the traditional 60-40 portfolio. Bonds have not provided the core diversification they did historically because of all those challenging inflation dynamics that we discussed. People have spoken about the death of the 60-40 strategy, but WisdomTree was well ahead. Right before the pandemic, we launched the 75-25 strategy as the new 60-40 comparator. Then we branded a Siegel Longevity Model tied to that. This model plays a significant role on the Merrill platforms and is part of our efforts to promote the Siegel income models. I've been collaborating with Professor Siegel for 20 years, and later this quarter, we will publish the sixth edition of Stocks for the Long Run. For the first time in our relationship, I will be joining as a co-author on the book. We discuss at length how long-term forces drive lower expected returns in core bonds, which are likely to persist for some time. So we feel our WisdomTree models are particularly well-positioned with incursions from our high-dividend products, benefiting from strong long-term performance, making them a good anchor to the Siegel branded model portfolio. Overall, we're incredibly well-positioned with Professor Siegel as our partner in navigating future models, and his involvement will continue to increase as this new book is released later this year.

Jeremy, next question?

Operator, what's in the queue?

I'm showing no further questions at this time. I would now like to turn the call back over to Jonathan Steinberg, CEO, for closing remarks.

Thank you very much. We'll just thank you for your participation on the call. We look forward to speaking to you next quarter. Thank you.

This concludes today's conference. Thank you for participating. You may now disconnect.