Capital International, now Morgan Stanley Capital International (MSCI), published its first global equity index in 1968. Since then, MSCI has become a global index behemoth. More than US$16 trillion in assets is benchmarked to MSCI products, including the well-known MSCI World Index. Most of the world's leading asset managers use MSCI products to build portfolios and to benchmark investment performance.
MSCI, as the publisher of more than 250,000 daily indices, plays a core role in global capital markets. The index teams at MSCI set standards for investors by deciding which stocks and markets are worthy of inclusion in the closely followed indices. These decisions move stock prices and send billions of dollars of capital across international borders.
MSCI's index business has expanded extensively on the back of two key drivers, with more room to grow. The first driver, the growing popularity of global investing, expanded MSCI's client base. As asset owners looked to diversify holdings away from single domestic markets, the MSCI World Index, and its counterparts such as the MSCI Emerging Markets Index, served an expanding client need. Investors used the indices to define investable universes, monitor and manage portfolio risk, and benchmark investment performance.
The second driver, growth in passive investing, has widened the reach of MSCI index decisions. Passive investment strategies replicate an underlying index, delegating stock selection to the index publisher such as MSCI. MSCI indices are replicated by passive ETF assets that hold over US$1.3 trillion in assets. The outlook remains rosy given the relatively low penetration of global passive products.
But, MSCI is more than an index publisher. Motivated to "help clients build better portfolios for a better world," MSCI leverages its core position in the index industry to build tools for investors to assess and manage portfolio risk. No risk appears more front of mind for investors than ESG and climate change, and here MSCI excels.
MSCI has earned itself a pivotal role in the ESG (environmental, social and corporate governance) investing revolution. Its product set includes one of the broadest sets of ESG ratings (covering more than 14,000 issuers), leading climate risk-assessment tools, and ESG and climate risk-adjusted versions of the popular MSCI global indices. No fewer than 48 of the top 50 asset managers (of almost 2,000 clients) subscribe to MSCI ESG Research ratings, and MSCI is the number one provider of ESG indices used in passive strategies. Just as MSCI World Index decisions influence capital flows, MSCI's ESG ratings are starting to do the same. In a rapidly growing market, MSCI is becoming entrenched in investor flows much like in its index business.
MSCI’s index business (about 80% of earnings) has strong network effects. Asset allocators and asset managers benefit from using the same standards, much like two people speaking the same language. Asset allocators familiar with MSCI indices would likely prefer to benchmark an asset manager's investment performance against an MSCI index than an alternative they hadn't heard of. Similarly, asset managers would prefer to use the MSCI index, which they too are familiar with, over one they weren't familiar with. Once entrenched, neither the asset allocator nor the asset manager is likely to switch. As allocators and asset managers grow familiar with MSCI's ESG standards, the same effect is occurring, building a stable recurring revenue stream for MSCI to allocate to new products. Given this network effect, for established relationships and benchmarks, there is little competition.
MSCI management has long followed this approach, using stable and growing cash flows from the core index business to build new business lines. ESG and climate tools are only one of two future new growth areas for MSCI. The second is a longer-term opportunity to build what MSCI describes as the "holy grail," an index of all investible assets. Combining listed and unlisted markets across equity and fixed income into one index methodology, MSCI hopes to become a one-stop shop for all investors globally. While there is greater competition in the development of new benchmarks, if MSCI’s history is a guide, the company is well placed to play a leading role in these longer-term opportunities.
Overall, MSCI is a high-quality business that has a unique growth profile and risk exposure to financial markets. MSCI stands to benefit from the long-term growth of passive and ESG investing while displaying defensive characteristics, given the high level of subscription revenues.
Sources: Company filings and website