MSCI Inc

NYSE:MSCI

Earnings Call Transcript 2018-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the MSCI Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session where we will limit participants to one question and one follow-up. Further instructions will follow at that time. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host Mr. Andrew Wiechmann, Head of Investor Relations, Strategy and Corporate Development. You may begin.

[Andrew Wiechmann, MSCI, Inc.]

Thank you, Bridget. Good day and welcome to the MSCI second quarter 2018 earnings conference call. Earlier this morning, we issued a press release announcing our results for the second quarter 2018. A copy of the release and the slide presentation that we've prepared for this call may be viewed at msci.com under the Investor Relations tab.

Let me remind you that this call may contain forward-looking statements. You're cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made and are governed by the language on the second slide of today's presentation. For a discussion of additional risks and uncertainties, please see the risk factors and forward-looking statements in our most recent Form 10-K and our other SEC filings.

During today's call, in addition to GAAP results, we also refer to non-GAAP measures, including but not limited to adjusted EBITDA, adjusted EBITDA expenses, adjusted EPS and free cash flow. We believe our non-GAAP measures facilitate meaningful period-to-period comparisons and provide a baseline for the evolution of results. You'll find a reconciliation to the equivalent GAAP measures in the earnings materials and an explanation of why we deem this information to be meaningful as well as how management uses these measures on pages 23 to 27 of the earnings presentation. We will also discuss organic run rate growth figures, which exclude the impact of changes in foreign currency and the impact of acquisitions or divestitures.

On the call today are Henry Fernandez, our Chairman and CEO; Baer Pettit, our President; and Kathleen Winters, our Chief Financial Officer.

With that, let me now turn the call over to Mr. Henry Fernandez. Henry?

[Henry A. Fernandez, MSCI, Inc.]

Thanks, Andy, and thank you to everyone for joining us today. The record second quarter sales and the exceptional financial results are as a direct result of our deliberate and targeted investment in core, strategic areas of our firm. This investment to accelerate growth and profitability are centered around three areas; delivering actionable solutions, creating differentiated content and flexible technology to develop that content and enable it for use of our clients. Let me elaborate in each one of these areas.

First, actionable solutions refers to the usage of our products and services by our clients to achieve their specific investment objectives. Such usage may involve single or multiple MSCI product for services. The usage may also be supported by insight from our research team to help our clients understand how those tools can be utilized. We have been aggressively enhancing these actionable solutions by building out our client coverage our services, our research capabilities, and making investments in this content and this technology.

As you know all too well, the investment industry is undergoing a massive transformation with participants trying to sharpen their business models, creating efficiencies and scale, and trying to understand the drivers of performance and risk in their portfolios. This transformation is creating a huge opportunity for MSCI, manifesting itself in the great success that we're having with our solutions selling which will Baer discuss in more detail later.

Secondly, our relentless innovation in differentiated content is based on key bets. They are in equity content, such as are ESG Ratings, our enhanced Equity Factor Models, ESG and factor indices as well as our broader range of global custom and specialized indices. The key bets are also in fixed income and multi-asset class content, such as our new liquidity analytics, our enhanced library of cash flow models, our broader security coverage and our enhanced multi-asset class factor model; and also in private asset class content, such as our private equity and private real estate risk models, and our new global real estate information products.

Thirdly, these bets in actionable solutions and in differentiated content will be enabled by our investments in state-of-the-art and flexible technology in everything we do, from accessing outside data, processing to create content for us and for our clients, and enabling the use of our content by our clients.

In the last category, we are developing a truly unique client platform that will greatly enhance the value of our content as well as content from our clients and other third-parties. This client platform will provide functionality not currently available in the market and which will easily integrate within client workflows.

In the realm of technology, we're also increasingly employing proprietary and third-party machine learning and AI techniques to scale up our ability to gather and analyze data, automate and enhance the efficiency of many of our data processors, as well as generate unique research insights for our models.

In summary, clients are just beginning to embrace the full range of capabilities across MSCI and this is showing up in the increased sales and also record financial results of the company. Like Baer and our COO, Laurent Seyer, I've been spending half of my time on the road over the last year with C-level executives at many of the world's largest investment organizations. What I hear from many of them is that they want more engagement from MSCI to provide them with the products, the services, the research that they can use to help them solve their investment problems and capitalize on their business opportunities. Therefore, we're tremendously energized by the enormous opportunities ahead of this firm.

We are further excited by our ability to attract very talented and experienced professionals. In the last few months, we have announced the addition of the following senior executives. Our new Chief Technology Officer and Head of Engineering, Jigar Thakkar, had an impressive track record at Microsoft in software engineering leadership positions. Our new Head of Client Solutions, Russell Read, over the last two decades served as the Chief Investment Officer of Alaska Permanent, Gulf Investment Corporation in Kuwait, and CalPERS in California.

Our new Head of Asia-Pacific Coverage, Jack Lin, brings over 20 years of experience at Amundi, Pioneer, Janus, and Franklin Templeton. George Harrington, our new Global Head of Index, Futures and Options Licensing, brings over 20 years of experience in financial markets and global (9:03) changes at Bloomberg most recently. Stéphane Mattatia, our new Head of Index Products in Europe, brings over 15 years of experience in structured products at Société Générale. And lastly, and not least, our new Global Controller, Jen Mak, joins us from Honeywell where she was the Controller and Principal Accounting Officer. MSCI is becoming a magnet for extremely talented people with a mission to change the investment world. I am confident they will help the MSCI franchise to scale new heights.

Lastly, we're obsessively focused on investing only in our most core and attractive growth areas. We are highly disciplined about divesting of our product lines that are not fully aligned with our strategy, particularly if we do so at attractive market valuations. We announced this week that we'll be divesting InvestorForce, reflecting our commitment to allocating capital to its most strategic and highest return possible. This very intense focus on strategic core areas, effective capital allocation and maximum operating efficiency has allowed us to generate double-digit organic subscription run rate growth in Q2, substantially higher than the growth levels just a few years ago. Given the enormous growth opportunities and our track record of execution, we are excited about our long-term outlook.

Let me now turn the call over to Baer.

[C. D. Baer Pettit, MSCI, Inc.]

Thank you, Henry. I'll start on slide 5 highlighting in more detail the manner in which we are serving clients in new and innovative ways. The versatility and utility of our content and applications allow us to package our offerings for a wide range of use cases and help clients adapt to the fast-changing investment industry. Driven by our keen focus on increasing market penetration, there has been growing momentum in many of our key client segments, such as asset owners, asset managers, wealth managers, and broker dealers. Each segment experienced double-digit year-over-year subscription run rate growth and they collectively comprise around 85% of our subscription run rate.

Let me elaborate further in each of these categories, starting with asset owners. Asset owners are increasingly insourcing portions of their investment activities. Consequently, these clients are using our analytics, ES&G contacts and our indexes, including factor and ES&G indexes to assist them with understanding their portfolio risks, managing their exposures and achieving their overall investment objectives.

Following a recent multi-product solution sale, a large U.S. pension fund, who already uses our market cap indexes as policy benchmarks, will begin to implement factor strategies across their plan. The pension fund chose to license our multi-asset class factor analytics platform to support them in portfolio construction and risk management. They also licensed our models to allow factor exposure reporting to their plan board and for evaluating the factor performance drivers of their active portfolio.

Additionally, they made an allocation to track an MSCI Factor Index, leading to downstream revenue for us. Our client coverage and research teams with support from the executive team played a key role in helping the client understand how the range of our capabilities can be used together. These type of opportunities have driven year-over-year subscription run rate growth of 16% across the asset owner client segment.

Turning to active asset managers, this segment is increasingly looking to differentiate themselves and explain how they create value. To enable this, active asset managers are turning to MSCI and leveraging our content like factor analytics to construct strategies that demonstrate differentiated alpha and manage factor bets.

Increasing numbers of clients are licensing our ES&G ratings to highlight favorable ES&G practices. This is also our largest segment for multi-asset class risk and performance analytics. These opportunities drove year-over-year subscription run rate growth of 11% across this client segment.

Within broker dealers, we're finding numerous new opportunities to help them better serve their retail and institutional clients with structured products, like index-linked notes or factor overlay instruments increasingly with ES&G tilts. Overall, year-on-year subscription run rate growth was 10% within this segment.

This opportunity has been further enhanced by growing liquidity in the MSCI-based index and futures options markets. Q2 run rate in futures and options, based on our indexes, was up approximately 36% year-on-year. We're seeing similar One MSCI demand from wealth managers, whose need to build model portfolios based on our indexes is helping to fuel 10% plus growth rate within this client segment.

We are better able to identify these type of opportunities through enhanced go-to-market strategies. In addition to our established client relationships at the user level, we are increasingly engaging the C-Suite at our clients and leveraging our research team to engage with investment professionals at our clients about how they can use our products and services to help them achieve better investment-related objectives.

Now let's turn to slide 6. Slide 6 highlights some of the key statistics, which reflect the benefits of these opportunities. As you can see, more and more clients are using products from across all segments, and our largest clients are growing at a higher growth rate than the rest. We also see the benefits of these opportunities in our strategic account manager program. Our strategic clients comprise our largest clients, representing 41% of our total subscription run rate, and both key statistics such as 11% subscription run rate growth and 95.7% retention rate. We've had a strong pipeline of new product enhancements in the first half of the year, which will continue into the next two quarters.

With that, I turn the call over to Kathleen.

[Kathleen A. Winters, MSCI, Inc.]

Thanks, Baer, and hello to everyone on the call. I'll start on slide 7. Q2 was a great quarter. Our franchise is as strong as ever and we continue to execute at a high level as you can see by the exceptional revenue and EPS growth and strong cash flows. We are executing many organic growth opportunities and building on our track record of delivering robust returns. We remain very focused on driving a disciplined approach to our investments.

Revenue growth in the quarter was primarily driven by recurring subscription revenue with continued strength in index and ESG, up 13% and 25% respectively. ABF revenue growth was fueled primarily by growth in AUM of equity ETF linked to our indexes, with average AUM in MSCI-linked equity ETF up 31% from the same period last year. This was largely driven by strong cash inflows over the last 12 months with MSCI-linked equity ETFs capturing 21% of total market share over that period as well as market appreciation year-over-year.

On slide 8, you can see the drivers of adjusted EPS growth. Our strong execution in the quarter resulted in high-quality earnings growth, mainly driven by the operating momentum we continue to drive. The EPS benefit from higher revenue is primarily driven by the tailwinds provided by our investments over the years in areas like factors and ESG, and engagement with clients at the C-Suite level. We experienced a positive impact as a result of tax reform and increased interest income from cash investments, partially offset by incremental interest expense due to the new financing.

Now, let's turn to our segment results on slide 10. Within the Index segment, we had strong subscription revenue growth driven by higher growth client segments, like wealth managers, broker dealers as well as asset managers, coupled with outsized growth in our newer modules. We continue to deliver new content. For example, we launched 125 new China A Indexes and expanded our ESG module history. Our focus on expanding use cases and gaining new clients helped drive growth of 7% in our Analytics segment, excluding the impact of foreign currency and the divestiture of our FEA business. Asset managers and asset owners were significant contributors with year-over-year run rate growth of 11% and 12%, respectively. We remain cautiously optimistic about the momentum we are seeing.

Within Analytics, on July 30, we announced the planned divestiture of InvestorForce, which provides workflow services used by investment consultants to construct the performance reports for their clients. The sale is expected to close in late Q3 or early Q4. In our All Other segment, the growth was mainly driven by ESG, with strong growth in EMEA, which represents 41% of total ESG run rate; and strong growth in our ESG Ratings product as investors increasingly integrate ESG into their investment processes.

Slide 11 provides a summary of our key operating metrics by segment. Organic subscription run rate growth further accelerated, up 10.2%, substantially higher than the 4% level just five years ago. Net new was up over 50% across all segments. In Index, we had strong growth in asset-based fee and subscription run rate, up 21% and 12%, respectively. We've had great momentum in asset-based fees, as we continue to drive asset owner mandates and licenses to our indexes for new equity ETFs and passive funds. Within the Index subscription run rate, we generated 14% growth in EMEA due to continued expansion of content and deeper client engagement.

Asia also performed well, up 15%, driven by momentum in China and Japan. Our largest client segment, asset managers, grew 10% in subscription run rate as our innovation continues to enhance our content and services. We've also had great success with sales into segments like asset owners growing 23% and wealth managers growing 29%. We continue to gain traction in selling factor and ESG modules with subscription run rate up 42% and 43%, respectively. Custom and specialized modules have also performed very well, growing 22% and 20%, respectively.

Index recorded its best recurring sales quarter ever and the Q2 Index retention rate remained very strong at 95.9%. Within Analytics, the run rate growth was driven by continued success within our multi-asset class analytics with run rate up 10% and within our equity analytics up 7%. The analytics retention rate was 92.1%. Cancels in Analytics were higher compared to prior year and were driven by broker dealer and hedge fund clients, where we saw client cost pressures with the closing of trading desks, hedge fund closures, and partial cancellations at clients looking to reduce costs. We're increasing our efforts around refining our go-to-market strategy and client service model to mitigate and offset cancel risks.

The recurring net new growth for Analytics was up 55.5% versus the prior year with strength in sales of multi-asset class products to asset owners and asset managers. On a first half basis, net new was up 15%, excluding the impact of the FEA divestiture. Sales and cancel activity in this segment are lumpy due to the more sizable and complex deals in the pipeline. Given this lumpiness, we look at the longer-term run rate trend as we assess and evaluate the performance of the product segment. You can see by the momentum in our Analytics run rate that we continue to execute our roadmap to deliver improved growth.

Slide 12 highlights the drivers of our asset-based fees in more detail. Equity ETFs linked to MSCI Indexes now totaled slightly over 1,000 ETFs and reflect one of the most globally diversified group of ETFs in the industry with about 20% exposure to the U.S. markets and the remainder spread across emerging markets and developed markets outside the U.S. Year-to-date, we've licensed our indexes to 59 new equity ETFs, 38 of which are based on our factor and ESG indexes. The total number of equity ETFs benchmarked to our factor and ESG indexes is 326, which represents 26% of all equity ETFs based on factor and ESG indexes, more than any other provider.

Total AUM of these equity ETFs linked to our factor and ESG indexes have grown by 36% compared to last year, bringing the total to $97 billion as of June 30. Total AUM was down 2.6% from the end of Q1 and was primarily driven by a decline in market values and a modest cash outflow from the equity ETFs linked to our indexes. We saw cash flows predominantly moving into U.S. and global equity ETF, and out of emerging markets and developed markets outside the U.S. The market declines and flows out of EM and DM ex-U.S. also impacted the average basis points, given that these ETFs are typically relatively higher fee products.

Looking at our mix, cash inflows went when primarily into products with lower total expense ratios, which tend to carry lower average basis point fees. We continue to expect lower fee products to capture a disproportionate share of new flows into equity ETF. And we expect a further decline in our average basis point fee levels as part of our efforts to achieve continued run rate growth. Our ETF partners are continually evaluating their market opportunities for existing and new products, as well as the optimal positioning and pricing of those products. And as such, we have discussions with all of our key partners about our fees and fee constructs on an ongoing basis.

Now, let's turn to slide 13, where we provide some additional detail on the quarterly net cash flows of the equity ETFs linked to MCI indexes. Given the movement this quarter, we think it is important to provide some commentary around the Q2 flows and our longer-term view of the space. Let's start with what happened with global flows. As you know, there was an overall slowdown in global flows into equity ETFs during Q2. Specifically, there was $60 billion in net flows in Q2 into equity ETFs, which was only about half of the $120 billion average over the last five quarters.

Furthermore, of that $60 billion, about 80% went into U.S. equity ETFs as investors are favoring U.S. exposure. There were several factors that drove the slowdown in geographic rotation. Investors have heightened uncertainty due to international trade tensions and geopolitical risks. These concerns, coupled with and related to the strengthening of the U.S. dollar and recent international market underperformance, drove investors out of emerging markets and developed markets ex-U.S. and into U.S. funds, including higher-quality fixed-income funds.

Now, turning to MSCI-specific flows, these dynamics resulted in net outflows from equity ETFs linked to MSCI indexes during the second quarter. On a first half basis, we had strong flows and market share gains. ETFs based on our indexes captured flows across all markets and into key growth areas such as factor and ESG indexes. In emerging markets, ETFs based on our indexes captured flows of about 36%, reflecting our strength outside the U.S. and significantly higher share of equity ETFs in these markets. ETFs based on our factor and ESG indexes on a combined basis captured 25% of flows, and U.S. equity ETFs linked to MSCI indexes captured 14% of flows, markedly higher than the 10% we captured in all of 2017.

We remain confident in the long-term secular trends in the ETF space and our strategy of structuring our licensing agreements with ETF providers to increase our market share through volume growth to drive long-term run rate growth. If there is ongoing market volatility, we believe we are well positioned to manage through periods of downturn given the strength of our subscription business and the readiness of our downturn playbook. If you look at the last 10 years through other market downturns, our index subscription run rates have continued to perform well, growing around 10% or higher each year.

Turning to Analytics, slide 14 provides you with additional detail on the Analytics trajectory. Following investments in restructuring initiatives over the last several years, we've driven gradual improvement in both run rate growth and margin. We continued to enhance our offerings and go-to-market efforts and have seen accelerating growth in our focus areas of equity analytics and multi-asset class analytics. These two areas make up nearly 90% of the Analytics run rate.

Additionally, equity analytics is a key component of and differentiator for our factor indexes, providing a key benefit to our high growth Factor Index franchise.

Outside of these areas, we have a few smaller product offerings which have had lower or negative growth. For certain products, we're in the process of enhancing the capabilities and migrating functionalities to improve growth. For non-core products, we have divested these offerings with the divestiture of FEA in Q2 and the recently announced sale of Investor Force Holdings.

Run rates for FEA and InvestorForce represented approximately $8 million and $17 million, respectively. And we do not expect a meaningful impact to the expense base as a result of the divestitures given our continued focus on investing in other areas to drive growth.

On slide 15, we provide an update on two strategically key areas of integrated content innovation where our bets are clearly paying off. Our growth in factors continues to be driven by the growing interest in diversifying exposures and understanding and designing portfolios around factors as clients seek to provide differentiated investment products.

Regarding ESG, new clients drove about 50% of recurring sales in the quarter. As ESG increasingly becomes an integral part of the investment process, we're focused on maintaining our position as a leader in the space. We continue to invest in our capabilities, broadening our ratings coverage, which currently stands at 13,000 issuers. We continue to scale up, supporting our global team of over 170 research analysts with increasing use of AI and machine learning technologies. As of June 30, there was nearly $11 billion of AUM in equity ETFs linked to our ESG index, which grew 74% year-over-year.

Turning to the next section, we provide an update on our capital, liquidity and our 2018 guidance. On slide 17, we provide our key balance sheet indicators. With the completion of our $500 million notes offering in May, our leverage has increased slightly above the high end of our targeted leverage range. The proceeds from this financing, combined with the existing cash on our balance sheet, has resulted in a very strong cash position. Consistent with our past practices, we intend to remain disciplined around the use of that cash and deploy it opportunistically for repurchases during times of increased volatility and targeted bolt-on M&A.

Additionally, our board of directors approved a 53% increase in our quarterly dividend on July 31. We're also increasing our dividend payout ratio target to a range of 40% to 50% of adjusted EPS from the previous range of 30% to 40%. This reflects the strength of our franchise and our confidence in our continued strong financial performance.

Slide 18 highlights our strong track record of returning capital. Year-to-date, we've deployed $223 million to repurchase a total of 1.5 million shares of our stock. With the exception of the change to our dividend policy, our approach to capital allocation remains the same with no changes to our leverage target or our approach to repurchases.

Lastly, as you see on slide 19, we have one update to our guidance. We expect interest expense of $133 million as a result of the May financing. Otherwise, our guidance and long-term targets remain the same. Also, I'd like to point out that while our adjusted EBITDA expense guidance range is consistent with our previous guidance, we currently expect to be at the higher end of our guidance range.

In summary, we had a very strong first half of the year as the team continues to execute extremely well against our strategy. The investments in high ROI projects have been a major tailwind for us as our franchise continues to strengthen. Our growth opportunities continue to expand and we are focused on continuing to deliver strong top-line growth. We very much look forward to keeping you updated on our progress.

With that, we'll open the line to take your questions.

[Operator]

And as a reminder, we ask that you please only ask one question and one follow-up at this time. Our first question comes from the line of Alex Kramm with UBS. Your line is open.

[Alex Kramm, UBS Securities LLC]

Yeah. Hey. Good morning, everyone. Would love for you guys to comment a little bit about the – I don't know if it's the topic du jour, but the announcement from Fidelity yesterday to basically move to a zero management fee product. Now, I know it was index mutual funds. I don't think you have a lot of exposure in that area anyways. But just curious what do you think that signals, if it's a change from the trajectory that we've been on when it comes to fee erosion in general. And I guess maybe just related to that, I think you made a comment around you will always negotiate and have discussions with your customers. Just want to press if there was anything new in that or why you made that comment, Kathleen, I think it was you. So, any bigger picture comments would be helpful here as well.

[Henry A. Fernandez, MSCI, Inc.]

No. Thanks for that question, Alex. There is relatively no new information coming out of the announcement of Fidelity. Basically, it is part of a trajectory in this industry, like any other industry, that when you have attractive returns in certain parts of the world, capital flows to that, participants flows to that, and it puts pressure, obviously, on pricing. So, we expect that to continue, for sure. We also expect that to be a long-term trend with certain step functions along the way, but it's a long-term trend. And therefore, we are focused with ourselves, with also our partners in either mutual fund managers, or index fund managers, or ETF managers, to optimize our opportunity in the context of those trends and those competitive dynamics. And what that is, is focused on what we call run rate growth or revenue growth and optimizing the tradeoff between volume and pricing and positioning obviously of our offerings and, in their case, their offerings, their investment offerings to the client base. So, that's what we have been doing for a very long time. If you want to think about it, that's what we did back in 2012 in the context of a large client leaving us at the time, and we ended up with recovery and a great result after that. So, that's that.

Now, with respect to the dialogue we have with all of our clients, including our largest clients is, obviously, we constantly have debate and discussions as to what is the right positioning strategy. They tell us what the view, their right position strategy for their investment products and how we fit into that as the supplier of the indices into those products, what is the appropriate distribution, to what type of client, what clients are more price sensitive, what client are less, what clients are focused more on liquidity of products versus long and hold, and therefore how do we optimize the volume price tradeoff in order to come out with a large amount of market share and a large amount of revenues. So, there's no difference what we've been doing in the past. My sense, Alex, is that those conversations will clearly continue at a fast pace and will intensify as the industry tries to find an equilibrium in all of this and tries to pick the winners and the losers in that equilibrium, and of course we want to be a large player among the winners.

[Alex Kramm, UBS Securities LLC]

Excellent. Thank you. And just shifting gears for a second, and I was very pleasantly surprised about the sales performance or net sales performance this quarter. Maybe if you can just flesh it out a little bit more. I think you've made comments or prepared us in the past that the second half of the year should be really where sales accelerate, given kind of like the changes you've made to the compensation structure. So, was there any pull forward, anything you would point out that maybe the second half may be on a different trajectory now or why was the second quarter just such a surprising stand-out, I guess?

[Henry A. Fernandez, MSCI, Inc.]

Look, I think the second quarter, similarly to the fourth quarter of 2017, are just early indications of the capital allocation we're making in terms of – let me back up, the strategic focus that we're trying to put in the highest and more strategic growth areas of our company as opposed to the ones that are not. And the ones that are not, we either divest them completely or we harvest them. So, that's the strategic focus.

The second part is the capital allocation we provide. We're putting a lot more capital on those strategic areas that are giving us high ROI opportunities, and medium or lower capitals to the ones that don't, but continue to be strategic. And obviously, in terms of profitability and, especially, funding of these investment initiatives, we are obsessively focused on continuously creating efficiencies in the company in order to free up money for profitability and free up money for investment. So, that's no different.

So, what you see in the growth rate, for example, Alex, is that clearly, we're very focused on factors – factor investing and within the whole compendium from factor analytics to factor indexes, and the like. We're very focused on the ESG ecosystem from ESG Research and coverage of securities, to ESG Ratings to ESG Indexes, and all that. And that is, obviously, another growth drivers of this. Within Analytics, when you go to page 14 of the slide, we wanted to give you this slide so you can see that the area that we care the most about, which is multi-asset class analytics and equity analytics, are the areas that are growing the most, 10% in the last period here on multi-asset class and fixed income, and 7% on equity analytics.

What the drive is, is this other area which has, this slide, $54 million of run rate and, by the way, this $54 million does include the $17 million run rate of InvestorForce that would obviously be out of that once we close that transaction. That is a little bit of a drag. And therefore, we're either divesting or improving or harvesting parts of that. So, what you see here is, in the growth of the revenue, it's obviously the investment that we're making, but also a little bit of a change of mix which is indexes is growing faster, ESG is growing faster, factor analytics are growing faster, and we're either divesting or depriving capital from those areas that are lower growth areas. And therefore, we will anticipate to see a continuation of this, but in a gradual process with some lumpiness quarter-by-quarter because of the Analytics segment.

[Alex Kramm, UBS Securities LLC]

Very good. Thank you.

[Operator]

And our next question comes from the line of Manav Patnaik with Barclays. Your line is open.

[Manav Patnaik, Barclays Capital, Inc.]

Thank you. Good morning, everybody. My first question was, I was hoping – Kathleen, you talked about your confidence in your recession playbook, and I was hoping you could just expand a little bit in terms of what some of those steps would be that you would take. Even now, it sounds like you're accelerating your index subscription growth, even though the backdrop is tough for the active managers. So, I was hoping for a few examples, anecdotes of what's in that playbook basically.

[Kathleen A. Winters, MSCI, Inc.]

Sure. So, first, I'd say, when you think about our cost structure, it's important to kind of understand that we're largely a people business, right, so we're comprised of people. And so, one of the things that we're constantly looking at – and we very much have a mindset of continuous improvement. We're constantly looking at, are we doing everything as efficiently as possible. And so, we're always looking for opportunities to drive efficiencies and leveraging technology to efficiencies. So, that is something that we're continuing to use as a lever for improvement.

In terms of should we go into a downturn environment, we look at our cost structure, and we say, okay, well, what are the components of our costs that are variable. And those are the types of things that we would lever up and down. For example, there are portions of compensation costs, obviously, that are variable costs. And so, those would be the levers that we would go to, and we would look at things that – first, we would look at things that would not impact our ability to invest and continue to drive top-line growth. So when we prepare that downturn playbook, it's very much prioritized in terms of kind of what are the Tier 1 things that don't impact our ability to grow. And then, we would have lower on that list other items.

[Manav Patnaik, Barclays Capital, Inc.]

Got it. And then just maybe just to round out the capital allocation comments you made. I guess you guys just sold InvestorForce. Is there an ongoing portfolio review of the company, did that just come up? Just some color on if there's anything in the back there.

[Kathleen A. Winters, MSCI, Inc.]

Yeah. So, portfolio review is always an ongoing process. I mean, we're doing that all of the time to make sure that we've got the right assets with the right growth profile in our firm in the portfolio. So, we've looked at the areas that have been lower or negative growth and said, those are – we're going to address that, as Henry said, either by divestiture or by improving that growth rate – enhancing the product and improving that growth rate. So, we've done, as you've noted, the two small divestitures here in terms of FEA and the pending InvestorForce divestiture. We're going to continue to look at the portfolio, but there's nothing substantial right now.

[Manav Patnaik, Barclays Capital, Inc.]

Got it. Thanks a lot.

[Operator]

Our next question is from the line of Toni Kaplan with Morgan Stanley. Your line is open.

[Toni M. Kaplan, Morgan Stanley & Co. LLC]

Hi. Good morning. Henry, you mentioned at the beginning of the call a number of new executive appointments, and there were quite a few there. So, I was wondering if you've had any, I guess, higher-than-unusual turnover or is it more related to expansion or a change of strategy? And could this result in a change in culture? And I'm not trying to imply that this would necessarily be negative, but just wanted to hear your thoughts on that. Thanks.

[Henry A. Fernandez, MSCI, Inc.]

Yeah. So, we've always been, Toni, a company that does both. We promote from within and bring talent laterally at all levels of the company. We try not to be either or, because there is always a great opportunity to bring new fresh, new blood – new fresher blood into the company and, obviously, reward the talents of the people that are in the company. So, there's no change in that here. Secondly, all these hires are part of the investment plan that we have in key strategic areas. We've mentioned C-level selling with our clients and solutions selling. So, Russell Read will play a large role in there. We talked about the technological transformation of the company. So, we have a saying inside MSCI that we need to become a Silicon Valley high-tech company. Whether we're there or we have a long way to go, I don't know. But we, for sure, will do that very hard, and Jigar comes to help us achieve that.

We talked about the – clearly, Asia is a big region that we want to focus on. We've had a vacancy there for about a year and a half in the head of that region. Laurent has been managing it day-to-day from London. So, that's a backfill there. Another example is, obviously, you heard us talk about the opportunity – the large opportunity we have in building index futures and options linked to MSCI indices, already helping exchanges do that around the world. So, we've beefed up that area with George Harrington coming to – so that we can put a lot more emphasis and grow that category, and so on and so forth. So, I don't think this is a change of policy at all. I don't think this an outside investment. It's all embedded in the total run rate of EBITDA and EBITDA expenses and all of that. And there's no change in policy and there's no change in the culture, because we've always done it this way.

[Toni M. Kaplan, Morgan Stanley & Co. LLC]

Okay. Great. And then while the retention is still exceptionally strong for each of the segments, the Index retention rate was down about 110 bps year-over-year and Analytics down by about 180 bps. Is there any one time items in either of those segments, just to help understand why the rates did drop even though they're still in the 90s? Thanks.

[Kathleen A. Winters, MSCI, Inc.]

Yeah. Hi, Toni. No, there's no particular one-time item there. Look, the retention rates, they kind of move up and down a little bit within a particular range. But 95.9% for Index and 92% for Analytics is very much within the kind of normal range of what we would expect.

[Toni M. Kaplan, Morgan Stanley & Co. LLC]

Thank you.

[Operator]

And our next question is from Chris Shutler with William Blair. Your line is open.

[Chris Charles Shutler, William Blair & Co. LLC]

Hey, guys. Good morning. I don't know if you already covered this or not, but I was hoping to get a little more color on the sales activity in the Index and Analytics and where there are lumpy items in the quarter and just how we should look at the sales on a go-forward basis.

[C. D. Baer Pettit, MSCI, Inc.]

Yeah. Look, I think the biggest thing here is we've been very consistent in our objective to show steady improvement in Analytics growth. And it's precisely the point that I was trying to make on slide 5 about the ecosystem that as our capabilities improve and as our clients see us execute effectively, it's become something of a virtuous circle. So, I think that we've been consistent in that story about Analytics. I think, there's nothing extraordinary in the Index numbers, per se. So look, we've said this before and it will continue to be the case that we cannot manage every – particularly, certain large sales may come a little – just after the quarter end or just before. But my headline here is, I wouldn't read too much into it. I think it's a consistent performance. I don't think it's an unusual performance. And we wouldn't view this as being an outlier in any way, and it's part of a steady trend.

[Kathleen A. Winters, MSCI, Inc.]

Yeah. So particularly in Analytics, where sometimes you can have larger deals that can kind of skew a quarter, in this instance, that's not the case. It was really – the strong sales are really comprised of many kind of normal sized deals, I would call them.

[Chris Charles Shutler, William Blair & Co. LLC]

Okay. And then on the Index, were there, I guess – it sounds like there weren't any extraordinary size deals or...

[C. D. Baer Pettit, MSCI, Inc.]

No.

[Kathleen A. Winters, MSCI, Inc.]

No.

[Chris Charles Shutler, William Blair & Co. LLC]

A little confused there.

[C. D. Baer Pettit, MSCI, Inc.]

No. Not at all. Just I would call it was a normal – normally successful quarter. Nothing unusual, no particularly outlier deals or anything that's worthy of comment.

[Kathleen A. Winters, MSCI, Inc.]

Yeah. I mean, it was pretty much broad, strong performance across the board within – if you look at index subscription, whether you look at it by content area, if you will, factors and ESG driving strong performance, each of the client segments doing really well and each of the regions showing strong performance as well.

[Chris Charles Shutler, William Blair & Co. LLC]

Okay. And then, Henry, on the whole Fidelity thing and, I think, JPMorgan a couple of months ago, do you think that we're going to see more and more of the index funds and ETFs using ETF providers as calculation agents, at least in the retail space? And can you give us – I know it's probably tough to answer, but at least a sense of magnitude of how the fees might differ if you're a calculation agent versus providing the index itself? Thanks.

[Henry A. Fernandez, MSCI, Inc.]

Yeah. So I think, Chris, there is no question that this category will continue to grow and that is the focus that we have at MSCI, how do we capture the significant amount of this growth in all this ETF and index funds and passive categories with our indices, how do we position them and all of that. And as part of that, we use tools such as pricing in order to capture volume and market share. We believe that in a growth trajectory of any product or any industry, the name of the game is to capture a lot of market share, because when it becomes fixed, it's a lot harder to do that, and then it's just a price game, right? So we do that.

Now, our indices are obviously invested by us and calculated by us. Other entities provide calculation services to clients that are sort of white labeling or vanilla calculation services. We tend not to do that. We only do that when either us or the client makes the content, so to speak, the index strategy together with a client, and then we serve as calculation of that using our universal securities, our infrastructure and the like. So, we're doing this with a few of the ETF managers that have been launching products recently and we get paid basis points on the basis of that. But we believe that we're adding value in terms of the creation of the content, not just being a calculator that can easily be replaced by somebody else in the future.

[Chris Charles Shutler, William Blair & Co. LLC]

Okay. Thank you.

[Operator]

Our next question is from Joseph Foresi with Cantor Fitzgerald. Your line is open.

[Joseph Foresi, Cantor Fitzgerald Securities]

Hi. You had an uptick in – and I know you talked about this a little bit earlier, but you had an uptick in the subscription portion of the growth rate. I wonder if you could provide a little bit more color on how you think about that, both short term and long term, and how sustainable that is.

[Henry A. Fernandez, MSCI, Inc.]

Yeah. So, there are two things that are – there are three things. One is, we clearly are trying really hard to consistently grow our subscription run rate in the low-teens, right, in the 10% to 11%, 10% to 12% kind of area. Given the recent past, say, the last five, seven years, it has not been growing in that area. The subscription run rate grew in the kind of 10% area in the five years leading up to 2017, or five years leading up to that. And then we're now trying to migrate to like 11%, 12% type of area. But we don't know, obviously, how successful we can be.

We're doing that by kind of three areas. The easiest area is divesting the things that have low growth or negative growth, and that's the categories in Analytics that we were talking about before. The second area is be an innovation machine so that you're adding content to that subscription that is growing at a much faster pace. ESG and factors will be in that category. And then thirdly, then making sure that the big ship (56:22), which is the big ship (56:23) of indices in the subscription who are multi-asset class risk and fixed income, for example, are not being dilutive to growth, but are actually being accretive to growth. So those are the three categories. So you will, hopefully, see a continuation of this.

If we continue to be effective at innovating and creating new content that, therefore, may start small, but over time becomes bigger and are higher growth rates, such as the factor space and the ESG space, and continuing to make constant improvement in growing the bigger run rate and then harvesting or getting rid of the things that are dilutive to that.

[Joseph Foresi, Cantor Fitzgerald Securities]

Got it.

[Kathleen A. Winters, MSCI, Inc.]

Yeah. So, Joe, just to point you to the data, you probably know that it's there, but in the appendix you can see total company and by segment subscription run rate growth over the last five years. So, you can see all of that information there. And you can see from that that our obsession and focus on driving that improved run rate growth is yielding itself in the numbers and the performance, and we're continuing to focus on that.

[Joseph Foresi, Cantor Fitzgerald Securities]

Got it. And just as a follow-up, I know you talked a little bit about pricing also in the opening remarks. How do you see pricing trending? And is that a tool for you to take market share or penetrate new markets? And how do you see the balance there with the margin profile? Thanks.

[Henry A. Fernandez, MSCI, Inc.]

Yeah. So remember, pricing – we are a multi-product company. We're not a multi-business company, we're a multi-product, one business company. So, therefore, pricing varies by product line. We do price increases in our index subscription, we do price increases in a lot of our analytics. We're beginning to do price increases in our real estate product lines and the like. So then, we clearly have been doing price increases on our particular ESG and factor indices or what we call institutional passive type of products.

The category that pricing is either static or declining is the ETF category, sort of as an example. So, we continue to see that happening as scale builds up and efficiency builds up in the industry and as people are trying to capture the market share in the industry. And we are a provider of the index into those managers. And therefore, we want to align our strategy in terms of content, in terms of pricing and in terms of volume, our market share to the strategy of those ETF managers. So, that will definitely continue.

What we want to focus on is the growth of the run rate, which is made up of volume or market share, and pricing. In the past, there has been an enormous (59:36) amount of focus on only the pricing part, not the volume part, but the pricing is a tool that is being used to drive and market share in order to create higher revenue. And we'll continue to see that in the industry and we'll continue to do that ourselves.

[Joseph Foresi, Cantor Fitzgerald Securities]

Thank you.

[Operator]

Our next question is from Hamzah Mazari with Macquarie. Your line is open.

[Hamzah Mazari, Macquarie Capital (USA), Inc.]

Good afternoon. Thank you. Was hoping you could sort of make any comments on self-indexing, I know you've spoken to your customer base. Any updated views on that or what you're hearing that may be different and sort of your viewpoint there.

[Henry A. Fernandez, MSCI, Inc.]

Yeah, so we believe that will continue in the marketplace, and let me tell you why. Look, in the distant past, indices were used only as references to build portfolios. It was more of a guide to build a portfolio. What is happening now is that indices – the building of indices and the creation of indices, they are becoming the portfolio itself. The index is the underlying basis of the portfolio itself. So therefore, it will be – it is ingenious to think that the entire investment industry is just going to rely on third-party indices to beat the underlying basis for their actual portfolios. And therefore, you will see clients create portfolios all the time, all the time, right. That's what their job is, creating portfolios.

Some of those portfolios will be created by clients and be – have that referenced against an index. Some of those portfolios will be created by client with an underlying third-party index, like ours. And some of those portfolios will – the clients will say, look, I created a portfolio, I want to turn it into a formulaic approach to the portfolio and, therefore, I'll call it self-indexing. So, I don't see why that will not continue or even accelerate, because it's part of the portfolio creation, portfolio management process in the world. So, I see that happening, and that doesn't mean that is a threat to us. If anything, we will help clients create self-indexes in order to – because that's the job. We help clients achieve their goals. So part of their goals may be creating self-indexes, and in those self-indexes, for example, we may be the underlying securities, because we have that. We may be the underlying calculation of it and so on and so forth. So, we see that evolving in the industry.

[Hamzah Mazari, Macquarie Capital (USA), Inc.]

Great. And just a follow-up, you had mentioned factor and ESG indices are, I think, 23% market share, which is pretty large. Maybe if you could frame for us how that compares to your overall market share and how you think about that market share and runway going forward on the factor and ESG. And then just curious how that compares to how you judge your overall market share? Thanks.

[Henry A. Fernandez, MSCI, Inc.]

We will get back to you on the exact numbers to make sure that we have the same information. We don't want to take a little time on the call, but we'll get back to you. And if anybody has that question, we can do that as well. What we can tell you is that we are the largest provider of factor indices in the world and we're the largest provider of ESG indices in the world probably by a wide margin – by relatively wide margin. So, we are the leader in the space, in number of indices, in number of ETFs underlying this indices, passive – other institutional passive funds underlying this indices and all of that, and we intend to remain doing that. And therefore, we have a meaningful amount of market share here that we want to continue and increase. And we can give you the exact dollar amounts in terms of market shares, and the exact amounts of the assets benchmarked to this passive or active and all of that.

[Hamzah Mazari, Macquarie Capital (USA), Inc.]

Sure. We will connect offline. Thank you.

[Operator]

Our next question is from Patrick O'Shaughnessy with Raymond James. Your line is open.

[Patrick J. O'Shaughnessy, Raymond James & Associates, Inc.]

Hey, good afternoon. Question on your ESG business. How much of your growth there would you say is from market share gains and how much is really just kind of going after a whitespace opportunity?

[Henry A. Fernandez, MSCI, Inc.]

Whitespace opportunity, there is no such thing as displacing anybody in this space at this point.

[Patrick J. O'Shaughnessy, Raymond James & Associates, Inc.]

Great. Thank you. And then, for my follow-up, as we look at your asset-based revenues, can you maybe give a little bit more color – I know you spoke about it briefly earlier, but a little bit more color on the really impressive growth you've seen in your non-ETF revenues?

[Henry A. Fernandez, MSCI, Inc.]

On the passive side, so that – on the ABF, the asset-based fee category is made up of three components, right. The largest component is, obviously, ETF fees. The second largest is other forms of passive fees that are not ETF, that could be institutional passive, as we call it, and the like. And the third category is the futures and options on our indices, which is obviously growing pretty large.

So on your question, which is the second category, the reason it's growing a lot is for two reasons. One is that, obviously, the category of institutional passive is growing just like the same way you see ETF, which are basically mostly passive, growing. The over-the-counter, so to speak, as opposed to exchange-traded category, is also growing, either institutional passive or mutual fund passive, and that is obviously providing that growth. The second growth is on the pricing. The part of the category that is market cap indices has had relatively low pricing for a long time, particularly the institutional part of that. But the ESG and factor part of that we're pricing at a much higher level, sometimes multiples of the level that we're pricing the market cap part of that category. And that is creating significant benefit.

So, specifically, when a pension fund decides to invest passively, but not in ETF – I'm saying passively on ESG mandate or a factor mandate, or better yet the combination of factors and ESG, the index fee associated with that, either passively managed or actively managed, in this case, obviously, we're talking about passively managed, is higher than the market cap – the traditional market cap category.

[Patrick J. O'Shaughnessy, Raymond James & Associates, Inc.]

All right. That's helpful. Thank you.

[Operator]

Our next question is from Henry Chien with BMO. Your line is open.

[Henry Sou Chien, BMO Capital Markets (United States)]

Hey, guys. Good afternoon. Just had a question on some of the changes or the additions to your management team. And I was just curious on the sales side, I mean it seems like you're targeting a number of new areas in the industry, whether it's wealth management and broker dealers. And just curious how you're thinking about the sales strategy there and are you sort of accelerating your sales push to sort of take advantage of that demand for these new products?

[C. D. Baer Pettit, MSCI, Inc.]

Yes, for sure. Absolutely. So, I think those are both categories where we have clearly seen attractive growth over the last number of years and we felt that the business was both at an inflection point in terms of its scale and its growth potential that additional senior leadership could really make the most of that. So, I think it's really a sign, if you like, from a – not from a product point of view, but from a client point of view of – partly product in the futures and options area and partly client type, of the continued diversification of our portfolio. And the point that I was making on slide 5 of how our ecosystem becomes a virtuous circle. So, we're very pleased that we feel we can make these sort of investments, because that's what they are. They're investments in our colleagues, in humans, and we really feel confident that they will pay off in the next year and the years ahead.

[Henry Sou Chien, BMO Capital Markets (United States)]

Great. And just then my follow-up, in terms of the investment cycle, is the priority still ESG and factors, or – any updated thoughts on how you're thinking about product investment? Thanks.

[Henry A. Fernandez, MSCI, Inc.]

I'm sorry. Repeat that question again. We...

[Henry Sou Chien, BMO Capital Markets (United States)]

Yeah. So, I was just curious on your, I guess, investment plans for products. Is it still kind of staying the course and continuing to invest in the ESG and factors, or if just any updated thoughts on whether you're kind of exploring new areas as well?

[Henry A. Fernandez, MSCI, Inc.]

Yeah. We clearly have a full hand here with the current content and also the technology to enable that content, both to produce that content, but also to distribute that content to our clients. So, that's already a fairly full deck of things. But we are gradually investing in other areas. Private asset classes is one example there. Clearly, we have been investing in the real estate – in the private real estate area that we don't talk about much on these calls, we should in the future. We are putting sort of seed investments in infrastructure, for example. Obviously, we have made investments in – that's on the performance side. On the risk side, we made investment on the private equity risk models and the private real estate risk models and the likes. So, that's one area that we are focused on, on the product side. And as you mentioned, on the client side, we have big opportunities on wealth, on exchanges, be it with futures and options. At some point, we will want to expand our coverage of life insurance companies, for example, and the like. So, we're only scratching the surface in many of these newer client segments.

[Henry Sou Chien, BMO Capital Markets (United States)]

Okay. Great. That's super helpful. Thanks so much.

[Operator]

And our next question is from Vincent Hung with Autonomous. Your line is open.

[Vincent Hung, Autonomous Research US LP]

Hi. Just one from me. I just wanted to dig a bit further into the dialog you're having with ETF issuers. So, are clients negotiating price reductions around all of the MSCI-linked ETFs they have or around a specific ETF? So, whether it's like the old suite versus the new. I guess, you probably have more pricing power on the larger more liquid established products. And just to tack on to that, are they using this threat of self-indexing as a potential bargaining chip?

[Henry A. Fernandez, MSCI, Inc.]

No, most, if not all, of our clients are not. They want to do business with us and we have great relationships with them. So, it's not a question of threats or else I'll go anywhere. I mean, we believe that we add enormous amount of value to our clients, particularly our ETF manager clients, especially by the large following exemplified in the $14 trillion of assets that are following MSCI indices. So, to some extent, when a client launches a new ETF, it's a little bit of a call option in converting a bit of that amount of money into their products or attracting it into their products. So now, we don't comment on specific negotiations at all, whatsoever. But for sure, we always talk about everything. We talk about the new product lines. We talk about existing product lines. We talk about new geographies, because we look at the ETF market as if it were a one giant market and all homogeneous, it's very, very different. You have segments – you have geographies. The competitive dynamics in Europe are very different than the competitive dynamics in the U.S. and completely different than the competitive dynamics in Asia. Within those markets, the competitive dynamics on low cost retail products is very different than the competitive dynamics on institutional ETF or ETF that are highly used by institutions. The value proposition is very different. Institutions are looking to move large amounts of money with high liquidity and very tight bid/ask spreads. A lot of the retail marketplace is a buy and hold kind of investors and so on and so forth.

So, we're looking to segment all of that market and have ongoing conversations with our clients about all of the components of that to maximize the fabric of or the tapestry of revenue in the context of volume and price and differentiation and value added in each one of the categories, whether it's a market category, or segment, or a geography, or a product segment.

[Vincent Hung, Autonomous Research US LP]

Thanks.

[Operator]

And I'm not showing any further questions. I'll now turn the call back over to Andrew Wiechmann for closing remarks.

[Andrew Wiechmann, MSCI, Inc.]

Thank you so much, and thank you to everyone for joining us today. We really appreciate the continued interest in the MSCI story. We look forward to keeping you guys posted on our progress. And as always, please feel free to reach out to me with any additional questions. Hope, you all have a great day. Thanks.

[Operator]

Ladies and gentlemen, this does conclude the program. You may now disconnect.