I was recently asked to write questions for a panel discussion on "Emerging Trends in the Asset Management Industry." Included in the list were questions on an increased interest in global investing, growth of passive investment products such as ETFs, importance of risk management tools in the wake of the financial crisis, and a more active role in understanding corporate governance by the buy side.
Spinouts from large organizations often offer growing and innovative divisions more oxygen to flourish outside of the confines of large and complex institutions. Supporting that position is MSCI (MSCI). Started in the 1960s within Morgan Stanley (MS), MSCI was a pioneer in developing global indices. It was fully spun out from its parent company in 2008. Coincidentally, a risk management business formed within JPMorgan (JPM), Riskmetrics, also split from its parent in 2008. These two organizations merged their businesses in 2010 and now hold a portfolio of asset management tools that are at the center of a variety of secular trends within the industry.
The largest business within MSCI is the Equity Index business. Readers likely are familiar with their indices being mentioned in all forms of financial journalism as the benchmark for global investing. MSCI All-World Index (ACWI) is just one of 150,000 like indices covering 76 countries and a variety of investment styles. In each case, MSCI sells the returns and composition data of these indices to a range of over 2,500 asset managers, pension funds, hedge funds, consultants and banks. With an ever-increasing interest in global investing, this steady subscription business is at the core of MSCI and represents more than 40% of the firm's revenue.
With the explosive growth in ETF investing, 524 of MSCI's indices have ETFs modeled on their composition with an aggregate invested dollar value of more than $350 billion (as of the end of February). This allows MSCI to participate in an asset-based fee-sharing arrangement that leverages the company directly to the growth in investment inflows into their indices. While asset flows and ETF valuation are unpredictable in the short to medium term, it would be hard to conceive of a future investment environment where global ETFs do not continue to attract capital. This segment of the business is the source of margin and growth variability; thus far in 2012, it would appear to be positively underestimated in both cases.
These index-related products allow global benchmarking and easily established passive investment allocations to previously hard to reach segments around the globe. Therefore, it is logically complimentary for MSCI to offer these same investment management firms the tools to track and report risk across a broader array of investment markets. Focused primarily on multi-asset class portfolios, RiskManager and the BarraOne product line offer tools to model and report portfolio risk and aid in the construction and management of a diversified portfolio. Add in the ISS governance business that allows investment managers to evaluate its options in voting corporate proxies, and what do you get: the basic toolbox for the current investment management world.
I often focus on sustainability and predictability over absolute growth. That is certainly the case with MSCI, as 96% of its revenues are recurring (mostly paid one year in advance) and more than 80% are from subscriptions. This steady business profile experienced 10% revenue growth in 2011, and as an indicator of the scalability and operating leverage of the business, delivered 17% EBITDA growth over the last five years.
Like every investment, it is just as important to be aware of what could go wrong as it is to explore what could go right. In MSCI's case, the predominant risk is a downturn in the global markets, which would impact both asset-based fees and its customers' ability to afford MSCI products. Secondarily, MSCI has an over 8% exposure to investment behemoth Blackrock. Should Blackrock decide to enter any of these markets independently, that would have an immediate negative impact on results.
That said, there are only a few powerful and long lasting secular trends in the asset management industry. Globalization of investing and managing the risks associated with this trend put MSCI in a solid position to be the tool provider to the evolving investment world where both growth in capital and an expanding roster of clients will propel results.