MSCI Inc. (MSCI) Earnings Call Transcript & Summary

Good afternoon, everybody. Thank you for joining us at our financials conference again this year. Unfortunately, we are virtual again. Hopefully, next year, we'll be back in person. But my name is Manav Patnaik, I'm Barclays' business and information services analyst. And I'm very pleased to have with me today, Baer Pettit, who's the President and COO at MSCI. So Baer, thank you so much for being here.

Hello, Manav. Very happy to be here.

Just for the audience, I mean, I will be doing a fireside chat with Baer. [Operator Instructions] With that, Baer, just to get started, I mean, clearly, MSCI is a leader in going after a lot of massive TAMs out there. So I just wanted to tackle each of those separately. So maybe just start with the whole active to passive trend that we've been witnessing for quite some time. What is -- where are we in that penetration or the percentage that's passive? And how much -- how many -- how much runway is left here?

Yes. So it's one of those questions that I've been asked many times in my career at MSCI. And I fear my answer never gets that much better, so I apologize for that. So I'll just make a few general observations. Look, we just actually had a small group of senior advisers this morning for MSCI, 10 -- low-teens number of very large institutional investors and the topic came up. And so for sure, there's no sign that there will be a reversion in the -- in where we are. So i.e., the rough allocation between active and passive. The variety of -- and by the way, we typically don't use that expression at MSCI, we use indexed because I think the other very major change that has occurred in the last, call it, decade plus, is clearly that many indexed exposures are in a rules-based active portfolios. They're not the market portfolio, they are various types of strategy portfolios, be that factor, be that ESG, et cetera. So I think that if you look at traditional sort of finance theory, many of the indexed products out there, from a theoretical point of view, are not the market portfolio and have many of the characteristics of active. And then finally, I think the notion -- the one argument put forward is that the index funds have too much influence on the market. And that's one point that's often made. And the second is that they don't take corporate responsibility seriously. I think on the first point, actually, the amount of index funds arguably create more interesting alpha opportunities for active funds because they can do more with less money. So that's, I think, a key point. And the other one is clearly now, these days, some of the largest index investors are very, very much engaged in corporate responsibility and engaging with companies, notwithstanding the fact that they may be indexed. So I think all -- with all of that being what it is, my bias is that we'll still continue to see some light gain of, if you like, market share from index to active. I don't think it will be dramatic, but I think the main point being is that these categories are very different than they were 10, 15, 20 years ago.

Got it. I think that characterization you made of indexed versus passive, I think, is important because obviously, there's more and more of that indexation going on. One of the questions we often get is just the threat from self-indexing, if your clients or the bigger players try and do it. Is that a threat? How do you address that?

Look, that one, I've been pretty consistent on this topic. And I truly -- I don't mean this in an arrogant way or sort of puffing up MSCI, but I think the self-indexing argument has various demerits. And I think that there are 2 chief ones. One is just the kind of the separation of the index provider and the manager, I think, is an element of integrity that a lot of end investors, be they individuals, individual investors or institutions like. Secondly, and this has notably been the case since the advent of index regulation in EMEA, which de facto becomes almost a kind of global regulation, because if you run one index process, it has to meet the EU criteria. That running an index business is certainly not a matter of doing a calculation in a spreadsheet, there's a lot of steps in it. There's a lot of process involved. And so I think that not many firms want to take on that regulatory and sort of process obligation. So I just don't think -- that doesn't mean that there won't be self-indexing, but I don't see it being kind of a scale competitive risk to us.

Got it. And just beyond that, I mean the competitive dynamics within indexing, I mean it's been pretty stable for some time. Every now and then, I guess you see a start-up pop up. But are there any threats to look out for? Or is it kind of more of the same?

Look, I think, first of all, it is a competitive landscape. There are -- if you just look as an example, I think -- I don't know what the latest number is, but MSCI is clearly a very major index provider. We have, I think, the latest numbers. We're 20% market share in ETFs, right? So -- and there's no really explicitly dominant party. There clearly have been some various start-ups in various specialist areas. I don't -- I'm not clear entirely whether if one looks forward in, let's say, 5 years' time, what will be the breakup of the market share. But I think that the industry has been competitive for some time. And I think that the -- you've seen innovation, you've seen change in different types of indexes, you've seen change in the regulatory environment, which we've all had to adapt to. So I think in that sense, we show aspects of being kind of a resilient business, which has faced a competitive environment for some time. And again, I want to be very cautious because there could be elements in the environment that could change the competitive dynamic. But at present, I don't see a lot of that.

All right. That's good. Most of the discussion, I think, has been primarily focused on the equity side of the picture. And I wanted to just ask, I mean, a lot of both you and your competitors have been trying to get into the fixed income side of things, but it's been hard. So what is MSCI's strategy there? And how should we look at what to expect?

Sure. Yes. So maybe a few different things. So we've clearly done a few things in partnership. We have our ESG partnership with Bloomberg in fixed income, which has been very successful, and I think we're very pleased with and Bloomberg is very pleased with. We've started building out some of our own index suites. We've deliberately done that in a very kind of frugal manner. So we have -- it's only been going now for a fairly short amount of time. I think in the next year, we'll start to have a pretty broad suite of indexes there. We didn't want to do a kind of "build it and they will come" approach. We're working with specific clients to develop some things notably related to ESG and climate. And we actually have some quite interesting partnerships that we're working on in fixed income, which I hope we'll be able to make some announcements in the not-too-distant future in between now and year-end. So I think we're making, I would say, steady progress. Again, there -- the main lens that we see the opportunity through is kind of as a service to our clients, rather than saying we're going to go displace competitor X or competitor Y. A lot of times in client dialogues, people say, "Well, if you had -- oh, could you do the same in fixed income, notably around ESG and climate?" And that's kind of what pushed us in that direction. But look, if we look ahead, let's say, if we were to fast forward a year from now, I think at the margin, we might have done more in fixed income between now and then than some people might expect today. But my style is rather to overpromise -- excuse me, underpromise and overdeliver. So I don't really want to -- I don't want to go there today.

I think you almost gave Salli a heart attack there. Just in terms of the index business, you have obviously the part that we track based on AUMs, but then you have a really strong subscription business that's been opening strong double-digit growth for a long, long time. What are the drivers of that double-digit growth for a subscription business like that?

Yes. Well, I think the -- sort of mechanically, I think the -- there are 2 things, which is, one, maintaining growth in our traditional market cap areas, but strongly supplementing that with new model -- new modules and new areas, right? So I think were it not for some of the innovative things we are doing, we wouldn't have been able to maintain that growth. So I don't have the exact numbers in front of me right now, but I think it's really been a great combination of having a very strong franchise to start with, but ensuring that we continue to innovate, so that in areas, whether it be in factors or in ESG and climate, we're able to build those type of subscription data products on top of our historic ones. And so I think it's -- that's kind of the winning formula, make the most of what we have, but also continue to be creative and add to all that.

Got it. So that product mix that you just talked about, that makes sense. Can you just address a little bit from the client side? Like what is your mix of clients on that side of the business? And are they all growing? Or is there one or 2 things...

Yes. So I think, look, the noteworthy element which is -- which by definition has to be true for the math to work out is that even for the innovative indexes, which are not the traditional market cap benchmarks, the vast majority of the subscribers are active managers, either traditional long-only managers or clearly, even categories like hedge funds. And they may not -- a lot of the interest of these type of products is often to better understand market trends, to better understand the performance, for example, in ESG and climate of certain ratings of companies over time. So I think what's -- what I think is really I think interesting and often understated element of that franchise is that, of course, it has 2 key utilities. One is to -- for these indexes to service benchmarks; two, for them to service the underlying for index products or various kinds. But they're also used a lot more as a research tool and an analytical tool by a lot of investors. And I think it's that element of them, which is, for sure, been an important part of the growth trajectory.

Got it. And just to round up the index segment, I mean, you have the small but fast-growing derivatives futures business. Can you just talk about -- I think compared to S&P at least, you're much smaller. Is that just because the -- it was a change in strategy recently? Or how we should think about that?

Yes. Well, look, I think it's really to do with the history of the firms, right? So I think where S&P started was with the 500 and with tradable products around it, and so much more around the world of trading than the world of investing. And conversely, MSCI started kind of from the other end, we started much from the world of investing and selling data products, and so we're kind of -- we came from opposite ends. And those elements are still, I think, pretty much present in our culture. But I think the derivatives component has clearly grown quite a bit over the last number of years. I would say, objectively just based on the benchmarks that the various derivatives are linked to, there should still be quite a bit of upside with that. And so we're continuing to be focused on our futures franchise, but we're also trying to do more to expand our options franchise where we haven't really been very present. And our belief is and the belief of the various -- our partners that we're working with is that if we can continue to build up the options franchise as well as the futures franchise, it becomes a kind of virtuous circle of creating more liquidity and hence, a bigger franchise. So by definition, it is a hard category to -- I would say, it's a harder category to predict the direction of because there are elements there from traders, which are different than, let's say, a data subscription model. But I think we're moving in the right direction, and we think we still have a lot of upside there.

Got it. That's good to hear. So now before we get into the whole ESG topic, I wanted to touch on just kind of your quest for private asset class data. And maybe if you could just help set the stage, take a step back. I think the first big push was your partnership with Burgiss and I think yesterday, they merged or bought some -- I guess, Caissa, if I said that right, or whatever. Can you just talk to us about...

Yes. Caissa.

Yes. So can you just talk to us about what is the quest here?

Sure. No, no, of course. And I think it really is important to set it in context because otherwise, these things just become like another bright shiny object and you can't see the wood for the trees, right? So look, taking a step all the way back, MSCI's mission is to help our clients build better portfolios. And in turn, our largest clients are institutional investors. And our major -- historically, we were kind of a very equity-focused firm going back 20 years ago and then through various acquisitions, we got into other aspects of the public markets, notably fixed income. But we continued to hear from many of our clients that if you want to serve us to help us fully understand the risk and return of our total portfolio, you have to do more in private asset classes from the clients you would expect, from sovereign wealth funds, from large pension funds who have private asset allocations, et cetera. So our initial focus was to help build better risk models around all of that. This led to the acquisition we did in real estate. And so we've been continuously looking in private assets to see things that would make sense for us, right? So here we are, we're at an inflection point where we made an additional acquisition in real estate with RCA, who are a leader in the pricing area of buildings across the world, which we think will be a great addition to what we do. We have our minority stake in Burgiss, who are, again, a huge leader across private assets. And in turn, and this is a little bit of a two-layer structure here, Burgiss acquired Caissa, who are a company that builds multi-asset class tools, which notably have seen quite a lot of success with endowments and foundations, who are clearly very heavily -- have a little heavy weight to private assets in their portfolio. So the long story short is we're building out a set of capabilities here. We believe that, again, I don't have an exact time frame, but in the next, call it, 5 to 10 years, that there will be a revolution in private assets and that there will be much more available in terms of analytics, that some of these very small service providers will merge or be acquired and that in that environment, there'll be a big opportunity for us. So this is definitely not what I would call something we assume to be an overnight thing. And maybe to a lesser -- all these categories are not necessarily always comparable. But if you look back to, let's say, a decade ago, no one was chewing our arm off around ESG and climate. But 5 years ago, a bit, and now it's an enormous growth area. So these are a series of strategic investments. We will have to bring them together in a smart way. We'll have to refine the products, which is exactly what we did with ESG and climate. But we believe these are really sound, long-term investments if MSCI is going to be a leader in providing risk and return analytics tools to all categories of investors across both public and private markets.

Got it. That makes sense. So it sounds like Caissa is the analytic technology, but maybe can you help us like with Burgiss, like what is the data that they own?

Sure. So Burgiss is -- primarily serves the LPs or what we, typically in public markets, call the asset owners. And they gather data from -- typically from the -- which has come to them from the GPs and they provide a lot of comparability and transparency services into a whole variety of private asset investments, notably in private equity, but also in real estate and private debt and a few other areas. So in essence, the service that they provide is to really bring together a lot of data, which is not necessarily consistent in private markets and to help the allocators of money, endowments, foundations and other asset owners to make informed decisions about private asset classes. And hence, the fit with Caissa is, Caissa is doing that across all asset classes and they were both -- they were kind of in a kind of partner/competitor situation as often happens, it can happen in life. And so now they've come together. And we're very excited about it. In view of our -- although the acquisition is by Burgiss, in view of our shareholding in Burgiss and our membership with the Board at Burgiss, we were involved in the transaction and party to the transaction, and we're delighted with it.

Got it. And just broadly in this landscape, is there a lot of different data assets sitting out there? Or is this one where it takes time to build up, and that's why Burgiss pops up once in a while?

I think it's more the latter, right? So I think this is a whole area that's still in a nascent stage. There are some companies who've gathered data from public sources, there are some companies that are servicing the GPs in their workflows. There are some companies that are serving more of the LPs in their investment process. And even the largest companies in this area, you say providing services to either the managers or the owners of private assets, the largest companies in this space are quite modest compared to the size of company servicing public markets. And we believe that will change with time, right? So that's kind of a bet that we're making.

Got it. And then you've talked a lot about kind of MP&A as your strategy before. And so I'm just curious on the Real Capital Analytics acquisition. What was the difference between partnering and acquiring there?

Yes. So look, I think -- as I think many -- a few people at MSCI have said before to you and others over the years, what matters in real estate? Location, location, location. What matters at MSCI? Data, data, data. So we're kind of financial data junkies and with good reason, because we feel we can create enormous amounts of value out of it. RCA has a fantastic breadth and depth to what they do. We think that they're quite unique. They've been very focused and leading in a particular area for some time. The breadth and depth of their database, the manner that they collect it, the relationships they have to get the data, all of those things were -- are first rate. And so we had been aware of them and in contact with them for a number of years. I first met with the outgoing CEO. I can't remember now, 3, 4 years ago. So this is a firm that we've had friendly discussions with, we were very aware of for some time, and we're delighted we came to this outcome, and I think they should be an important addition to what we do.

Got it. And in terms of just how we should think about capital allocation going forward, just your priorities between the deal pipeline and the flow out there, the quest for data that everyone seems to be going after and just the buybacks?

Yes. Well, look, so I would say that our general approach to buybacks hasn't altered. We've said that we would respond when there was volatility and we thought there were opportunities. Sometimes that judgment gets affected by circumstances i.e., our stock has gone up dramatically, which has been great. So I think we have various understandings with our Board of Directors around how we'll do that. So we'll have to see how that plays out. But I think what -- I would characterize that as being opportunistic and you are always eager to give capital back to our shareholders on what we think are the right terms. And then I would say, generally, we've had sufficient cash. As you know, we did various debt offerings. We've had sufficient cash to give us some flexibility to take advantage of opportunities like RCA. The very nature of companies coming up for sale is that one typically can't choose when it happens. It happens when they -- more when they want -- you can try to make it happen when you want it to happen, but it often happens when they want it to happen. But -- so I would say that if you think about it, just in crude terms, market circumstances could be different today than 3 years ago or 5 years ago, but I don't think our approach to the topic has altered at all. We want to buy things, which we think will be a great bolt-ons to our franchise. We want to repurchase shares opportunistically when we think it will add value to the shareholders, and we have enough liquidity to do both. So hopefully, we'll kind of carry on in that way.

Got it. That makes sense. In the last 5 to 7 minutes, I wanted to touch on, obviously, the big topic out there, ESG. We probably need an hour for that. But just to start with, your numbers obviously speak for itself in terms of...

It has.

Executing on it, but whichever way you want to help us, but how do we frame this TAM? Like how long can this go on?

Yes. So look -- so based on what we're seeing and the trends that are happening in the world, the -- as you've seen, the growth is actually -- has actually been accelerating of late, when I say over the last few years. So I think we are at an inflection point where things are -- these topics are really affecting all investors, all investors. And I think if you divide it into 2 or 3 different ways of looking at the topic, so first of all, from -- on the whole, I would say broadly on ESG and sustainable investing, my first observation is that no investor -- quite literally almost no investor, I can't think of which one, can simply dismiss this topic. So even if they were to theoretically have a contrarian view, they have to engage with the data, they have to engage with the information and they have to have a thesis around it, right? That was not the case 5, 7, 10 years ago. So I think that is probably the single most dramatic thing that's happened, and it means it is the single largest driver of growth i.e., a very, very simple concept. You cannot ignore it. If you want to be brave and claim that it doesn't have any impact on a company's performance, you can do that, but you can only do that with reference to the data, right? So that's point number one. Point number two is climate as distinct from ESG. So the climate change topic has clearly accelerated a lot. And I think that there are maybe also a few different components to that. So the first one is purely that the environment -- the actions of governments around the world and regulators are putting a lot more emphasis on climate. That's not true in every jurisdiction. It's not true with every governance body, but for sure, that's the case. So similar to ESG, there's no -- no one can now claim to just ignore the topic. You have to deal with it one way or another. On -- equally, from a -- the second category, I would say, is kind of green and new energy opportunities are growing dramatically. So this is not merely a punitive topic, it's a topic with enormous opportunity, and a lot of capital is going to those opportunities. And then I would say while we -- I think we have to be careful of not conflating weather and climate, I do think that the weather events, which have been going on in the world in the last year, have had a dramatic impact on people's thinking. And there are parties who can take the other side of that argument, but I think it's -- they have had a huge impact on how institutions are reacting to what's going on. So taking all of that together, we still think we have an enormous upside in this category. And we're investing to make sure we make the most of that.

Got it. And I think on a big picture, all the clients, I think, now get it because they're obviously seeing it in their mandates and so forth every day. But just from a -- maybe from a competitive standpoint, a lot of the companies we cover, a lot of the exchanges, a lot of different acquisitions are going on there, consolidation. How should we think about that landscape? Is there going to be multiple winners? Or does it have to end up like the index, where there's 3 or 4 big players?

I won't be evasive in saying both. So I think there will be some leaders, but this is an enormously complex field, which is developing the whole time. And for sure, I don't think we want to be so intellectually arrogant as to say that we have like every answer, right? I think we have established a leadership position. We're investing dramatically. We're engaging not nearly with investors and companies. And we hope and we believe we'll continue to be a leader here. But this is, for sure, a rapidly evolving environment, and our behavior is to assume it will be extremely competitive and that we need to invest and stay ahead and be leaders. So I think when you're in this type of environment, to a degree, you're not that well served by claiming you have a crystal ball, you could really just say, we need to do the best we can and we need to make sure we're investing in the right places. We need to be obsessed with listening to our clients. And if you do all of those things and you try to be as competitive as you can and you invest in the right categories, then hopefully, you come out a winner. And the exact percentages of the market share, time will tell.

Got it. All right, fair. So in the interest of time, maybe just last question, and that's you're obviously investing in ESG organically. You're hiring a lot of resources, technology. But in the spirit of all the consolidation going on out there, do you feel like you have to participate in that consolidation? Or do you feel like you have the base assets that you need?

Look, I -- we never, I would say, as a philosophical thing, we and Henry and I have had this discussion for many years, we view each one of these things one step at a time, right? So I think it's always a discrete judgment on the particular company and we never want to be in what I would call like a race to purchase type of mindset. If you're in a race to purchase mindset, likely you're going to make a bad decision. So we just look at each discrete decision, and we hope to make the one that's the most informed and will ultimately serve our shareholders.

Got it. Fair enough. Baer, thank you so much. It sounds like a lot of good things happening at MSCI. I appreciate it.

Thank you. My pleasure. All the best. Thank you.

Thanks, everybody.

Bye-bye. Thanks.