MSCI's Crown Jewel Is Its Wide Moat Index Business

Equity Analyst

Rajiv Bhatia

Since going public in 2007, MSCI has become a leader in providing data and software to asset managers and asset owners. Its crown jewel is the index segment, which makes up about 60% of the firm’s revenue and 80% of operating profit. Through early leadership in non-U.S. indexes, MSCI boasts over $15 trillion in benchmarked assets. Because index data is critical to stakeholders that benchmark to MSCI, its index subscriptions have strong retention and pricing power.

About 41% of MSCI’s index segment revenue is asset-based fees, the largest bucket of which is from exchange-traded fund products. Though pressure on ETF expense ratios has weighed on MSCI’s license fee rate (which is roughly 2.5 basis points), the firm has benefited from market appreciation and robust net inflows as investors seek low-cost passive ETFs. Customer concentration is real, as BlackRock makes up almost half of MSCI’s asset-based fees. In 2019, MSCI signed a 10-year agreement with BlackRock that does include some pricing concessions, but we believe the 10-year horizon should solidify the relationship between MSCI and BlackRock. Outside of ETFs, MSCI earns fees for passive mutual funds and royalty revenue for the trading of MSCI-linked futures and options. 

MSCI’s analytics segment (about 25% of revenue) offers software subscriptions for risk and portfolio management analytics. Environmental, social, and governance data continues to be a focus for MSCI. MSCI's ESG data business is just under 10% of revenue but its fastest grower. In addition to data subscriptions, MSCI monetizes its ESG data in its index segment through ESG index subscriptions and license fees from ESG ETFs. 

Following pressure from ValueAct Capital in 2015, MSCI has been disciplined with operating expenses. As a result, adjusted EBITDA margins have grown from 41% in 2014 to 59% in 2022 with notable margin expansion in the firm’s analytics segment. Given that much of MSCI’s incremental revenue flows to the bottom line, we expect continued margin expansion, albeit at a slower pace.

Business Strategy & Outlook

We believe MSCI warrants a Morningstar Economic Moat Rating of Wide based on the intangible assets of its index franchise. 

MSCI has built a strong moat and brand with its flagship index benchmarks, notably the MSCI EAFE Index, the MSCI ACWI Index, and the MSCI Emerging Markets Index. MSCI monetizes its indexes in primarily three ways: subscriptions, asset-linked fees, and transaction royalties on exchange-traded futures and options.

Active asset managers pay to benchmark performance against an index. Index benchmarks are critical to asset owners, asset managers, and consultants, and they often have little incentive to switch benchmarks. Once an index becomes dominant in a segment, it tends to stay that way. An asset manager may prefer to be indexed against an S&P emerging-markets index, for example, but if asset owners and consultants prefer the MSCI Emerging Markets Index, the asset manager would risk outflows. In addition, the data subscription for active asset managers is a small percentage of the firm’s overall cost. MSCI’s growth in the index subscription business has been at a healthy 10% or so clip, with management suggesting that 3%-4% of this growth is driven by pricing. 

Another way MSCI monetizes its indexes intellectual property is through passive exchange-traded and mutual funds that track them. Net inflows and market appreciation have driven strong growth in the firm’s asset-based fees. MSCI’s ETF business is largely tied to BlackRock’s iShares franchise. In 2019, BlackRock and MSCI signed a 10-year agreement with respect to licensing. While the deal does include the potential for price reductions when certain asset tiers are hit, overall, the initial impact was less than feared. MSCI’s fees have some relationship to an ETF’s fee ratio. As an example, we believe the license fees earned on the iShares Core MSCI EAFE ETF (expense ratio 0.07%) is meaningfully less than the iShares MSCI EAFE ETF (expense ratio 0.32%). MSCI’s fee rate declined 15% from 2015 to 2019, which was less than the 18% decline in passive international equity fund fees based on Morningstar data. Even as fee rates decline, we still expect MSCI to garner a significant share of the value chain from its index franchise. 

MSCI also monetizes its index IP through the trading of options and futures of MSCI indexes. Given the outsize importance of the S&P 500 index in global equity markets (as well as the VIX), MSCI’s trading royalty revenue is significantly smaller than S&P’s, but off a smaller base, MSCI’s growth has been strong. Generally, index providers choose one exchange to be the exclusive venue of their licensed products. Because traders will go to where the index is traded, we believe the index providers have greater leverage than the exchanges. In 2007, Russell switched from CME Group to Intercontinental Exchange and then back to CME in 2017 for its index derivatives. In Asia, MSCI recently switched some of its business from the Singapore to Hong Kong exchange, and it noted on its third-quarter 2020 earnings call, "We are benefiting slightly from improved economics from our exchange partners, most notably in Asia versus the prior quarter," which supports our view of the index provider’s strong negotiating position. 

We view the MSCI analytics segment, which consists largely of its Barra and RiskMetrics acquisitions, as a narrow-moat business based on switching costs. The segment provides risk management, performance attribution, and portfolio management applications to asset owners and asset managers. Because MSCI analytics applications are embedded in their clients’ workflows, there are switching costs, and we believe firms don’t take the decision to switch providers lightly. That said, there are competitors, such as FactSet, BlackRock’s Aladdin, Axioma (Deutsche Boerse), and Bloomberg, and we believe users can be price-sensitive for these products. Unlike in index subscriptions, where a switch to a competitor is rare (losses tend to be from a firm shutting down), Analytics subscriptions cancellations are mixed between competitive defections and firms shutting down.

At just over 10% of firmwide revenue, MSCI’s ESG and climate data is a fast grower and has been an important focus for the firm. As an early mover and now market leader, MSCI’s ESG business boasts coverage of 14,800-plus issuers, has more than 700 climate change metrics, and covers 10,000-plus issuers. We believe that would be difficult for a competitor to match, and even so, MSCI’s long record (which could be useful to see how past performance of ESG metrics translated into performance) provides another barrier to entry. Given that the ESG market is still nascent and the level of embedding is much lower than other benchmark businesses (such as rating agencies and index providers), we believe this segment deserves a narrow moat rating.

Wide

Economic Moat

MSCI

MSCI, Inc. engages in the provision of investment decision support tools including indices, portfolio risk and performance analytics and corporate governance products and services. The company operates through the following business segments: Index, Analytics, Environmental, Social, and Governance (ESG), Real Estate, and Burgiss. The Index segment is involved in index-linked product creation and performance benchmarking, as well as portfolio construction and rebalancing, and asset allocation. The Analytics segment offers risk management, performance attribution and portfolio management content, applications, and services. The ESG segment offers products and services that help institutional investors understand how ESG factors can impact the long-term risk of investments. The Real Estate segment includes research, reporting, market data and benchmarking offerings that provide real estate performance analysis for funds, investors, and managers. The Burgiss segment provides investment decision support tools for private capital. The company was founded by Andrew Thomas Rudd in 1998 and is headquartered in New York, NY.

Earnings data Q2 2023

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MSCI, Inc. engages in the provision of investment decision support tools including indices, portfolio risk and performance analytics and corporate governance products and services. It operates through the following segments: Index, Analytics, ESG and Climate, and All Other-Private Assets. The Index segment focuses on the investment process, including developing indexed financial products. The Analytics segment offers risk management, performance attribution and portfolio management content, applications, and services. The ESG and Climate segment is involved in providing provide data, ratings, research, and tools to help investors navigate increasing regulation, meet new client demands and better integrate ESG and climate elements into their investment processes. The All Other-Private Assets segment engages in business intelligence products to real estate owners, managers, developers, and brokers. The company was founded by Andrew Thomas Rudd in 1998 and is headquartered in New York, NY.

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