The 2 Best Plays In An Industry That Could Double By 2020

Exchange-traded funds (ETFs) are exploding in popularity with retail and institutional investors alike. Financial services firm Price Waterhouse Coopers expects the ETF industry to at least double to $5 trillion in assets under management by 2020. This will mean big profits for two asset management companies who are leaders in the industry.

Exchange-traded funds are mostly commodity products. There are dozens of companies that offer an S&P 500 ETF, for example, and all hold the exact same companies. The best way an asset manager can differentiate itself among competitors is to become the lowest cost provider, which means being the biggest.

‚ÄčBlackRock, Inc. (NYSE: BLK) is a global asset management business and the world’s largest provider of ETFs. It has more than $1 trillion under management, spread across its many iShares funds. Blackrock is  growing assets under management in the iShares business at a compounded annual growth rate of 16% over the past five years. This rapid growth combined with a scalable business and low fixed costs, allows Blackrock to keep costs to customers low, which attracts more customers and assets.

iShares is only one quarter of Blackrock’s total business, but the evidence of the business’ tremendous operating leverage is apparent in the following chart from a Blackrock investor presentation.

As Blackrock has added assets, revenue has risen faster than costs. A business with this kind of fantastic operating leverage means margins expand and earnings growth accelerates. If the prediction about the ETF market doubling by 2020 comes to fruition, Blackrock will not only collect a lot more revenue, but every incremental dollar of revenue will be even more profitable for shareholders.

Earlier, I stated that ETFs were mostly commodity products with little differentiation. WisdomTree Investments, Inc. (Nasdaq: WETF) is the exception. As a much smaller player without the financial wherewithal to challenge companies like Blackrock in the traditional ETF market, it doesn’t even offer an S&P 500 fund.

What WisdomTree does offer is a suite of unique products. The fund company was a pioneer in the field of “smart beta,” a term that applies to indexes that augment traditional weightings (such as market capitalization) with added weightings for earnings growth or dividends. For instance, a WisdomTree index of companies that pay a growing dividend every year has outperformed a standard S&P 500 index fund since 2014.

This unique approach to index funds allows it to charge more for its service than a typical ETF provider. Blackrock, for example, charges a 0.10% expense fee on its market-cap weighted S&P 500 fund. WisdomTree’s proprietary dividend growth ETF, which contains mostly the same companies at different weights, charges a 0.28% expense fee. The higher fees help WisdomTree boost profit margins.

#-ad_banner-#Despite being a young company that is investing a lot of profits back into growth, WisdomTree’s operating margin grew five percentage points to 40% from 2013 to 2014, exceeding the margin growth that Blackrock has been able to achieve. As this business continues to mature, its margins will continue to climb.

The “smart beta” approach has also been a hit with consumers. WisdomTree has been in business since 2006, and in that time, it has grown assets under management to more than $53 billion from $748 million. That is a compounded annual growth rate of over 60%.  

Risks To Consider: Both of these businesses have been growing rapidly in an environment where all assets prices are rising and are highly affected by the global equity markets. Should there be a correction and asset prices fall, both would struggle to maintain such impressive growth.

Action To Take –> Blackrock and WisdomTree are great plays for the growing ETF movement in a way that allows you to beat the market. Blackrock offers a more diversified business model, and its shares carry a dividend yield of roughly 2.5%. It’s an excellent company to buy today and make a cornerstone of your portfolio. WisdomTree is the more speculative play and has been volatile, so wait for a pullback under $20 per share.

Blackrock not only sports a solid dividend but it and WisdomTree host many ETFs that do as well, which means now you need a strategy to milk the security for all it’s worth. Our resident income expert Amy Calistri began using The Daily Paycheck strategy to build long-term wealth using dividend payers. Since she began she has earned more than $76,000 in dividends. We, at StreetAuthority, have been so impressed that we urged her to spread the word to a wider audience. That’s why, for the first time, Amy took the stage to explain exactly how The Daily Paycheck strategy works. If you haven’t already, I encourage you to watch the exclusive presentation here. You won’t be disappointed.