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Even as Japan cools, ETF manager WisdomTree seen heating up

NEW YORK, March 28 (Reuters) - WisdomTree Investments Inc has paid a price for being so dependent on its flagship Japan fund - as that market reversed fortune this year, shares of the asset manager fell nearly 30 percent and Citi analysts downgraded its stock.

But the company and many of its followers are undeterred, saying it can use its unique position in the white-hot exchange-traded fund space to recover from that hit and continue to grow.

As the only publicly traded asset manager focused exclusively on ETFs, WisdomTree continues to attract institutional buyers and analysts who see the company as a potential takeover target, as well as having growth prospects of its own.

At about $12.88 per share, the fund company is still selling at more than twice its price at the beginning of 2012, even after this year's sell-off.

But to resume last year's climb, it will have to persuade investors that it can build size in a broader offering of its funds and reduce its dependence on its Japan Hedged Equity Fund , known to investors as DXJ.

WisdomTree's share price nearly tripled last year on the back of the outsized success of DXJ. That fund gained nearly 40 percent in 2013, as Japanese stocks went on a tear, the yen fell against the dollar and investors piled in.

"They essentially had lightening in a bottle last year, where they had a fund that was well positioned at the right time," said Jason Weyeneth, a New York-based senior asset management analyst with Sterne Agee. "Certainly we'd like to see the shares of some other funds grow and see their overall assets diversify a bit."

GROWING BEYOND DXJ

DXJ now accounts for roughly one-third of WisdomTree's total assets under management. It ended 2013 with more than $12 billion in assets, up from just over $1 billion a year earlier. Since then, its net asset value has fallen 10.3 percent and the fund has given back nearly $1.4 billion in assets, costing the company some $6.6 million in revenue.

That pullback was a concern for Citi analysts, who last week placed a sell rating on WisdomTree, saying among other things that DXJ's growth "may not be fully repeatable."

Other analysts are upbeat about the New York-based company and WisdomTree sees its exponential growth as a positive: "You cannot be a big fund company without big funds," the company said. (See a chart of the fund's growth and effect on the company at http://link.reuters.com/muh97v)

The company also has roughly a quarter of its assets tied to emerging markets and has been hurt as those markets sold off in 2014. Its second-largest fund, the Emerging Markets Equity Income Fund, is down 6.4 percent year to date.

AN ATTRACTIVE BUY

As long as WisdomTree can diversify its assets and attract more investors globally, analysts say, the ETF manager can ride the long-term growth wave of the ETF industry, which has grown from its first U.S. launches in 1993 to $2.4 trillion in global assets and is expected to expand exponentially over the coming years.

WisdomTree is currently the eighth-largest ETF manager globally with some $33 billion in assets. The company has found its niche by focusing exclusively on ETFs, unlike peers such as BlackRock Inc, which says ETFs make up about 21 percent of its total assets under management, and Invesco Ltd, which counts ETFs as about 13 percent of its total assets under management.

WisdomTree also counts among its backers a handful of Wall Street's more well-known individuals. Michael Steinhardt, a legendary investor and hedge fund pioneer, is the company's board chairman and largest shareholder, while Chief Executive Jonathan Steinberg is the husband of business news anchor Maria Bartiromo and son of longtime dealmaker Saul Steinberg.

Their colorful personalities, combined with WisdomTree's unique platform, may make it attractive to larger firms looking to add ETFs to their business.

"It's a digestible acquisition for a lot of asset managers," said Matt Hougan, president of San Francisco-based research and analytics firm ETF.com, noting that WisdomTree's platform "would instantly give them the footprint."

COMING OFF HIGH VALUATIONS

Surinder Thind, a San Francisco-based analyst at Jefferies who covers the company, said that WisdomTree's shares have long traded at a high valuation because of its growth prospects.

It was averaging along the lines of 20 percent organic asset growth each year, Thind said. Now that the company is seeing its inflows turn slightly negative - in part because of a pullback in Japan and emerging markets - some investors may be getting spooked.

Even after recent declines, the company trades at a forward price to earnings ratio of 22.7, still well above the average 16.2 valuation of larger competitors such as BlackRock and Invesco, according to Thomson Reuters data.

"When you have that terrific equity price and your business slows down a little bit, it's not surprising that the stock price comes down as dramatically as it has," said New York-based equity analyst Macrae Sykes of Gabelli & Co.

He said the sell-off in emerging markets has created "intermediate headwinds" for the company, but he sees the impact as short term.

SOME BUYING ON DECLINE

Craig Hodges, head portfolio manager of the $1.1 billion Hodges Small Cap Fund, has been adding to his position in WisdomTree as the company's shares have slipped.

He said he expects rising U.S. interest rates to prompt investors to take money out of bond funds and put them into stocks. "ETFs are going to get a very large portion of the flow back into equities," Hodges said, and WisdomTree offers a "pure play" on the growth of the ETF industry as traditional mutual funds have struggled to attract new investor dollars, he said.

Analysts tracked by Reuters have a median target price of $17 for WisdomTree, an approximately 35 percent increase from its current trading price of $12.58. Of the 11 analysts who cover the company, six rate it a buy or equivalent, while only Citi rates it a sell.

MORE DIVERSIFICATION EYED

WisdomTree is also known for its family of dividend ETFs, which have been strong performers and provide a smaller counterweight to its other funds. Its largest dividend ETF, the WisdomTree LargeCap Dividend Fund, added some $537.9 million in assets in 2013 and gained 24 percent last year.

Still, WisdomTree will need to continue to build out its ETF franchise to attract assets from more than a few key channels, analysts have said.

That way, a retreat in one region, such as the recent pullback in Japan markets, will not have such a large impact on the asset manager.

To that end, the company said in January it would be spending $20 million to take a majority stake in UK-based exchange-traded products provider Boost, a sign that the company is eyeing the European market for growth.

Europe, with roughly $9 trillion in invested assets, is the world's second-largest retail mutual fund market after the United States. ETFs make up only about 5 percent of invested assets in Europe, compared with a 13 percent in the United States.

Hougan said, "a sustainable business is going to come when they have five or 10 funds that (each) get $100 million every month."

(Reporting by Ashley Lau and David Randall; Editing by Linda Stern and Steve Orlofsky)