MSCI Inc. (MSCI) Earnings Call Transcript & Summary

Good afternoon. I'm Alex Hess, an associate on the business and info services equity research team, led by Andrew Steinerman here at JPMorgan. We're pleased to have with us today MSCI's CFO and Chief Strategy Officer, Andy Wiechmann, who has served the company in his role since September 2020. Andy has worked at MSCI in a number of leadership roles focused on strategy and finance for a while, but has been working with the company since 2006, having advised on MSCI's IPO as a banker. Welcome to Ultimate Services, Andy.

Thank you. Thank you, Alex. It's great to be here.

Great. So Andy, I want to start off with a historical point on MSCI that actually really informs your present. You've had great success over the years, winning over the ultimate asset owners to use MSCI indices. Maybe you could talk a bit about that. Are you significantly -- and then as a question for that, are you significantly tied to defined benefit pension assets? And how large is that at MSCI relative to, say, endowments, foundations, DC pensions, family offices, other institutions?

Yes. Sure. It's an important point that you're touching on which is, and one of the most exciting things about the MSCI franchise, is the layers of growth that we have. And so you can look at layers of growth across a number of dimensions. One is on the product side. We have products that are various phases of adoption and evolution that are adding higher growth rates on top of the compelling growth rates we have in more established areas. You can look at it across asset classes. And so beyond the traditional equity franchise that we've established, which continues to grow nicely, we're seeing tremendous success in fixed income as well as in areas like private assets. And then what you're touching on is client segments. And so within client segments, as you're alluding to, we've come from a position -- MSCI's history has been -- being strongly positioned with particularly defined benefit plans, pension funds, who incorporated our indexes as a benchmark, a benchmark for -- policy benchmark for their equity allocation often for their international allocation. And so we've become generally accepted among pension funds. By the way, there are a number of growth opportunities for us within pension funds as we move into other parts of their portfolio, whether that's capturing domestic wins as they start to incorporate ESG and Climate. And this is just talking about indexes, there's tremendous opportunities across other products as well. And then areas like institutional passive, which are increasingly being used by pension funds. And so we've got a strong position but compelling growth in it. But the thing that's so exciting is we have layers of growth in other asset owner categories where we're much smaller today. So you alluded to some of them. If you think about the largest pool of assets, investable assets, it's individual professionally managed or professionally advised assets through wealth management and defined contribution. Just to dimension this defined contribution -- or sorry, defined benefits. So pension fund assets are in the, call it, $25 trillion to $30 trillion. Wealth and defined contribution is probably $50 trillion. And so that is probably the largest pool of assets. That's an area where we're just starting to scratch the surface. We have about $80-and-change million of run rate within that segment today, growing at a tremendous growth rate. And there are a number of use cases that we're seeing there that make us very excited about the big opportunity we have there. Similarly, insurance companies, which is probably the second largest pool of assets. Historically, we haven't served on the heels of some of the fixed income capabilities, but also our ESG and Climate capabilities. We're starting to unlock that. And that's probably the second largest pool of assets. But as you alluded to, sovereign wealth funds, endowments, foundations, we're not nearly as penetrated in those areas. And as we develop things like our private asset tools, they're all big private asset investors. We have a wide range of solutions that we can deliver there. So very exciting dimensions of growth and just profiling that one across client segments.

Got it. That's very, very, very thoughtful. So maybe on the Index business specifically, MSCI reported a 12.6% increase in subscription run rate for the third quarter. For those of the guys -- for those of you in the audience who may not know the run rate metric, that's the annualized value of revenues, if you will, under contract for the next 12 months. There are puts and takes there, so it's not quite next 12-month revenue. But how would you decompose that growth between pricing, upsell, cross-sell, new client wins?

Yes. The point that I'd like to underscore is the largest source of growth, and probably will continue to be the largest source of growth for us, is doing more with existing clients. Now there are some client segments where we have a much smaller toehold, as I was talking about in the prior question, that are massive opportunities. But even within those, we're generally doing more for the clients that we already have. And so the largest source of new subscription sales is typically upsells and cross-sells to our existing clients. Behind that, it's price increase. And so we've said historically that around 1/3 of subscription sales, new subscription sales in index are to -- are attributable to price. In recent periods, and I mentioned this on the earnings call, we are generally increasing price more than we have historically, slightly more where we're factoring in the value that we're adding to clients, the overall pricing environment, our cost environment and cost structure. And so we're increasing prices across most of our products. And so price increase today here in recent quarters is probably high 30s, close to 40% of new subscription sales. And then the third component is new clients, so new clients that we're bringing on. But it is important for us to keep in mind as we deliver price increases and, oftentimes, we do it together with selling more to our clients, we need to continue to add value to them. Because we are going to be, as I said, the largest source of growth for us is with existing clients. And we want to be in a position where we're helping them operate more efficiently, more effectively and ultimately, capture more value. And so we usually bring together a broader compelling value proposition to them.

Got it. Very helpful. So on the last quarterly earnings call, custom indices were highlighted as a key driver in the third quarter, not prospectively, but in the present, so now. What sorts of clients are subscribing to solutions like Index Builder? Are they using MSCI tools to create direct indexing products? How long is the runway for growth? Maybe sort of flesh out that statement a little bit?

Yes. Custom indexes, and we're increasingly referring to them often as client-designed indexes, is a tremendous growth opportunity as you're saying. It's a growth driver today but a huge opportunity for us longer term. And we see it manifest itself across a number of different client segments and client use cases. Ultimately, it boils down to an index being a very efficient mechanism for an investor to implement a specific view on a market or sometimes an overlay or strategy or to manage risk systematically. And so MSCI's frameworks are designed very nicely for that use case. Firstly, -- we have -- we start with a global opportunity set, we call it ACWI, which is the addressable universe of investable securities. And we provide the frameworks within that to understand dimensions like geography, country, sector, size, style, increasingly ESG or climate considerations, factor considerations, thematic considerations, all in this interoperable, widely accepted high-quality framework. And so as an investor is looking to achieve a specific objective, we have that foundation and those foundational elements on top of our world-class Index franchise that enables them to do that. And so we see it being used in areas like, going back to your first question, institutional investors or asset owners like pension funds, sometimes a sovereign wealth fund who does something we call institutional passive mandates, where many times they will allocate assets against one of our off-the-shelf standard indexes. But oftentimes and, increasingly, they're deciding that they want a specific objective overlaid on that index. And so they will adjust the sector weight. They might put in an ESG consideration. They might filter out certain companies. They might want to put a factor overlay. And so we will help customize the index for them and productionize it, and then they'll put assets directly tracking that in this institutional passive mandate. We see it in broker-dealers who are creating products for their institutional clients in the form of over-the-counter derivatives or swaps or structured products. And many times, those are more customized products. And then an area that you've heard us talk more about, which could be very big, it's very early days today, is direct indexing. And that's where wealth managers, oftentimes working together with asset managers, are developing a personalized index for each individual, taking into account that individual's preferences, that individual's risk tolerance, financial planning goals as well as the house views. And then also, in many instances, and this is where a lot of the value is today, the tax positions and tax lots of that individual to achieve a better outcome. And again, we think we have a differentiated set of content and, ultimately, tools. And so you alluded to Index Builder, that's kind of taking it to the next level. Index Builder for us today is a tool used by our researchers or it's designed to be used by our researchers to turn around a custom index request more quickly. But ultimately, we want to put it in the hands of our clients to do some of that testing and design work on their own to streamline and speed up that process. And then ultimately, you automate it for things like direct indexing.

Great. Awesome. So if we maybe take a step back and look at a 5-year perspective over the next 5 years, what sorts of index products excite the MSCI team most? Is it the growth potential of brand-name market cap indices like the All Country World Index or the EAFE? Is it the continued adoption of ESG and Climate indices? Or is it something else like one of the other points we've talked on, [ some of it ]?

Yes. So all those are very exciting opportunities for us. We love all of our children the same. But if I had to focus on one, the area that's probably been the most impactful is in the ESG and Climate index front, where we've seen tremendous adoption of ESG and Climate indexes as benchmarks. We've seen it used as an index for passive mandates, both in those institutional passive use cases that I alluded to, but also for ETFs. And so ETFs is probably the most visible example where there's now approximately $200 billion of assets in equity ETFs tracking our indexes. That represents around 70% to the market. Or if you look at new flows into ESG and Climate ETFs in any given period, generally around 70% or north of 70% of those flows into ESG and Climate ETFs are going into ETFs tracking our indexes. Clearly, that is built on the strong franchise we have in our ESG ratings and our climate tools more broadly. But that is one that is opening up new channels of growth for us. I talked about at the beginning additional growth channels and pensions, but this is across all investors where we have opportunities to capture domestic market mandates, an area where we've historically not had as strong of a presence. It's opening doors in fixed income as well. So we have partnered with many of the leading fixed income index providers, and we have some proprietary indexes where we're starting to get some traction in the fixed income space, fixed income indexes and that's built on our ESG franchise. So it's particularly exciting for us, and we believe will continue to be a key driver of growth. I would say it's also, when we talk about custom indexes or client design indexes, oftentimes, it's some variant on an ESG or climate objective that we are customizing for that client based on their request. And so it permeates everything we do -- and not everything, but a lot of what we do in index, and it's increasingly permeating other parts of the company as well. So a very exciting opportunity for us.

Great. So since we've invoked ESG and Climate, let's maybe pivot to the research side of that business, which is its own distinct segment. So net new subscription sales were a bit soft in the third quarter, I think, it's fair to say. And you cited on the third quarter earnings call the impact of the market and the economy on that business. While appreciating that there may be an element of cyclicality to that ESG and Climate business, has anything structurally changed in your outlook for ESG over the next few years?

Yes. I would say structurally, there have not been notable changes to it. I mean ESG and Climate, which are related but also distinct, are both still front and center in the investment process and investor discussions. It's not something that they say they care less about today. They don't think climate is going away as a consideration. And so we continue to believe there are significant opportunities for the products we have today as well as the long list of new products that we will be developing to meet the needs of investors around ESG and Climate. So I'd say structurally, no change. We continue to be very bullish on the long-term opportunity. To your point, there are some cyclical and market dynamics at play. I alluded to this on our earnings call, but we did see some deals being pushed from the quarter. We saw a smaller amount of large-ticket deals. I think a lot of that can be attributable to the environment. And by the way, that's not necessarily just unique to ESG and Climate. We see some of those dynamics across other products given we're serving the same clients. The other thing that's been a factor over the last year is factors themselves. So in a lot of the largest ESG and Climate indexes that we have, there is an overweight towards high-growth companies, tech companies, professional service companies; underweight, oil and gas, weapons manufacturers, generally the value factor. And so as you've seen a rotation more out of growth into value, ESG from a cyclical perspective, some of the indexes might underperform. And so you've seen slowdown in flows into ESG and Climate ETFs relative to what we saw a couple of years ago. But those are really cyclical factors and you started to see those flows pick back up actually in recent months here, in recent quarters. And then I would say probably the most important thing I want to underscore is we do believe the growth rate is going to be dynamic by its nature. ESG is many different things to many different users, and we have many different tools for many different use cases. And so the pace of growth will fluctuate with the pace of growth in certain established client segments versus new client segments, with more established products versus new products, with regulations. So sometimes new regulations that are imposed can drive demand for our products. Sometimes a pending regulation can actually drive a slowdown in demand for certain ESG products that we have, where they want to wait -- clients want to wait to see what the regulation looks like, and then there are geographic dimensions to it. All those will cause the growth rate to fluctuate up and down in the segment. But those long-term trends are still very compelling to us.

That's great. That's great. So what gives you confidence? I know you guys speak sometimes to the breadth of your offering, but also that MSCI are advantaged with respect to the depth and quality of your ESG and Climate data versus many of your peers.

So probably the cleanest way to answer this is just to say we have the premium price offering out there. Generally, we are the most expensive tool, and that's a reflection of the quality and the capability that we have relative to competitors. And you can see the growth rate that we've been delivering, which is generally at or above the competitors that are aware of and publicly report the data. So it's not that we're losing market share. And you can see the retention rates that we've seen to this point, which have been remarkable. So we're not seeing a lot of clients at all cancel and move to competitors. On that point, we are remaining cautious because of the environmental factors that I alluded to earlier. We do -- we have seen in past downturns when there's sustained equity market pullbacks for several quarters, it leads to more client events and sometimes lengthening sales cycles. And so we are proceeding with caution. But generally, relative to competitors, we think we are very well positioned and continue to be the largest and highest growth provider out there.

Great. So a final question on ESG. There are many players trying to expand in this market. Many of them are here today. There's also a lot of start-ups. All of these companies are taking distinct approaches. In your view, could this industry perhaps look at something like the ratings agency business where you have many point solution providers of ESG data, or in the case of credit rating agencies, issuance data, default risk assessments, but like really there's a couple of trusted arbiters for a final rating, final overall assessment?

There could be similarities, but it will likely be different in structure. Credit ratings are unidimensional in nature, they're measuring the probability of default and severity of default of issue of a note or an instrument or an issuer. ESG is -- ESG ratings are more nuanced by nature. They're looking at a much wider range of considerations, and the financial impacts of those considerations do vary quite a bit sector to sector. And so I don't think you'll have that tight grouping and consistency of ratings that you see in credit ratings. And as a result, it's probably going to be difficult to be embedded into an investment mandate the same way you see an investment-grade mandate versus a high-yield mandate. And so there -- the comparisons do break down. But the thing that I think could be similar is the industry does benefit from having a common language to use to describe their position in ESG and Climate relative to a standard. And so I think while people might not and generally probably won't take absolute faith in our rating and they will have their own view, they can at least compare their position to their investors, to their clients relative to a standard out there which might be an MSCI. And so we think it does -- the industry does benefit, and we've seen this with other tools we have. The industry does benefit from using a common framework and common approach, and so we think there could be a benefit to having a small group of large providers. Related to that, we think if we have broad coverage, we have high-quality data. We have deep data that meets a lot of the needs of most investors and participants. And so there's not a need to have a wide range of data providers. And the data ultimately is equally, if not more important, than the top rating itself. And so as long as we continue to have the best quality data with the broadest coverage and deepest coverage, we think we're in a strong position to be one of the largest players in what will be likely a massive market.

So it seems like you do think your data is advantaged to some quality?

You got to it indirectly there.

So just -- because you touched on it very briefly, in past downturns, you have seen lengthening sales cycles, you had seen what are called client events. So that would be a firm shutting down, a hedge fund shutting down, a mutual fund shutting down, a trading desk closure, consolidations from M&A as AUM pressures maybe weigh on some managers. Have you seen any indications of those dynamics of late?

Yes. I mean you can see in our Q3 results, there hasn't been a significant impact to this point. As I alluded to in your earlier question, in ESG and Climate, we've seen some of that, but we've seen it more broadly across client segments where there is, in certain areas, caution. There can be slowdowns in purchasing decisions. And so we are remaining cautious. As you alluded to and we've said and I alluded to earlier, when you see these sustained equity market pullbacks, we know many of our clients that have their revenue and fees tied to assets under management are feeling pain. And so they are going to be looking to manage their budgets. Now our tools are mission-critical, and that's the thing we're encouraged by. If they're going to make purchasing decisions, it tends to be in the places where we're providing tools because we were helping them grow, going back to my earlier comments, adding value to them and they're probably the last area they want to cut. But when they do start to have layoffs, close desks, restructure, slow down fund launches, those things do trickle through to cancels and you can see our retention rate drop sometimes and you can also see sales cycles lengthening, and so some pressure on sales. So we are cautious.

All right. But your retention rate has been very strong as of 3Q.

It has been. Yes. No, we've been very pleased by it, but we are cautious looking forward here.

Good. So shifting gears to maybe an area of optimism, and let's talk about Real Capital Analytics. So it's been just over a year since MSCI acquired this business for almost $950 million. For those of you guys in the audience who may not know Real Capital Analytics, it's a real estate data and information business, publishes items like cap rates for sort of very detailed financial analysis, various asset classes. So I don't know, Houston office cap rate. What have been year 1 learnings from the RCA deal? Can you highlight some achievements in maybe some areas where there's still some work to be done?

Yes. And Baer mentioned this on the earnings call. So we've done the large majority of the integration. We've integrated the sales teams. We've started to do the product development work on the very unique data that they have, which you alluded to. And we continue to be very encouraged by the opportunity. We've seen, generally, our clients and their clients pleased that we are the home for RCA because the aspirations we have are things that they're looking for. They want deeper insights into the market, into what's driving performance of managers. They're excited about the suites of benchmarks we can release as well as things like climate tools. And so we continue to be encouraged by the long-term opportunity there. There is likely to be some cyclical pressure in this space. Many real estate participants and real estate investors are feeling some pressure with some of the movement in rates, you've seen slowdown in transaction volumes, real estate property transactions volumes. And well, we charge our clients a subscription service. Generally, if there are fewer transactions, there's less new data for them and arguably, that can cause some slowdown in some demand. And so we are -- another area that we are being cautious, but we hear strong feedback from our clients and continue to be very encouraged. And we're committed to the road map we have across new indexes for them, risk, liquidity insights, valuation insights and climate insights. And they provide a very unique capability for us to do those things.

So it sounds like you have a long road map with the things you plan to...

Absolutely.

That's awesome. So maybe to quickly shift on the downturn playbook. That's something that MSCI have done a great job of educating the market on is your ability to flex down adjusted EBITDA expense as the more cyclical or probably say even the AUM tied aspects of your business contract a bit. So the firm's full year 2022 expense guidance has been trimmed twice this year by about 7% midpoint to midpoint. At these expense levels, the present expense levels you've guided to, are you still investing for growth? And should investors think you just pushed back investment to next year or 2 years out that would have happened this year? Is it just a phasing issue? Or you're visiting, canceling some initiatives?

So Henry alluded to this on the earnings call, and he's given the executive order to me and the finance team that through the downturn actions, we are not touching our investment spend. So those discretionary investment areas that are critical to drive growth, establish leadership and today, create efficiencies, differentiate us relative to the competition. We are committed to investing in those areas. And so the downturn actions are not touching those today. It might make sense for me just to quickly go through what we are doing. And so it is important to underscore that we have had meaningful FX benefits on the expense base with the appreciating U.S. dollar. About 45% of our expenses are in non-U.S. dollar terms, and so that has been one factor why our expense guidance has come down. We have a meaningful self-adjusting expense lever, which is our compensation accruals or bonus accruals. A big portion of our bonus is tied to the performance of the company. And so when performance declines in this case because of ABF movements, the bonus accrual comes down. And so those 2 are automatic self-adjusting changes to expenses. Beyond that, we've gone to noncompensation areas, and we are very targeted in where we squeeze. So we do have professional fees that we have the ability to delay, oftentimes, put on hold, doing it in areas that are less time-sensitive and critical. We also can flex areas like T&E for nonclient-related, noncritical travel, internal events, business events. And so we've got a well-worn playbook there. And then on the compensation side, we mentioned this, slowing down hiring. So we are, on a very targeted basis, we will slow down the pace of hiring. We will close certain open positions in less critical areas. And actually, we have been proactive on the headcount management front as well. And so as part of the expense guidance we put out with our 3Q earnings, we include about $15 million of severance expense, which is quite a bit higher than we would typically have. And that's a reflection of the proactive actions that we're taking to position ourselves for next year. But we're being very targeted on those fronts to make sure we're doing it in areas that won't impact those critical investment areas, and really slow walking areas that are not as time-sensitive and not as critical to get done with urgency.

Got it. That's very helpful. And then can we have this fireside chat again maybe in a few seconds of us with something that you think isn't fully on investors' radar that would be highly impactful to MSCI?

So we're pretty good at putting everything on investors' radar screens. So I would say the areas that I hope to a year from now, be able to show some meaningful wins on, that we get very excited about that are small today, direct indexing. I talked about it earlier. Very much in its infancy, but an area we're intensely focused on. And then some broadening the private asset solutions and some of the stuff we talked about. We hope to continue to show some new launches and new wins on that front.

Got it. Thank you so much for your time today.

Thank you, Alex. Thank you, everyone.