MSCI: How 'The Customer Is Always Right' Leads To Shareholder Returns

seekingalpha08-21

MSCI provides investment decision support tools and solutions for institutional investors globally. Their products include indices, portfolio construction software, ESG solutions, and private asset ...

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Their products include indices, portfolio construction software, ESG solutions, and private asset ...</p>\n\n<a href=\"https://seekingalpha.com/article/4716157-msci-how-the-customer-is-always-right-leads-to-shareholder-returns\">Source Link</a>\n\n</div>\n","source":"seekingalpha","html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>MSCI: How 'The Customer Is Always Right' Leads To Shareholder Returns</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; line-height:1.5; color:#999; background:transparent; }\n.wrapper{ overflow:hidden;word-break:break-all;padding:10px; }\nh1,h2{ font-weight:normal; line-height:1.35; margin-bottom:.6em; }\nh3,h4,h5,h6{ line-height:1.35; margin-bottom:1em; }\nh1{ font-size:24px; }\nh2{ font-size:20px; }\nh3{ font-size:18px; }\nh4{ font-size:16px; }\nh5{ font-size:14px; }\nh6{ font-size:12px; }\np,ul,ol,blockquote,dl,table{ margin:1.2em 0; }\nul,ol{ margin-left:2em; }\nul{ list-style:disc; }\nol{ list-style:decimal; }\nli,li p{ margin:10px 0;}\nimg{ max-width:100%;display:block;margin:0 auto 1em; }\nblockquote{ color:#B5B2B1; border-left:3px solid #aaa; padding:1em; }\nstrong,b{font-weight:bold;}\nem,i{font-style:italic;}\ntable{ width:100%;border-collapse:collapse;border-spacing:1px;margin:1em 0;font-size:.9em; }\nth,td{ padding:5px;text-align:left;border:1px solid #aaa; }\nth{ font-weight:bold;background:#5d5d5d; }\n.symbol-link{font-weight:bold;}\n/* header{ border-bottom:1px solid #494756; } */\n.title{ margin:0 0 8px;line-height:1.3;color:#ddd; }\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nMSCI: How 'The Customer Is Always Right' Leads To Shareholder Returns\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-08-21 20:49 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4716157-msci-how-the-customer-is-always-right-leads-to-shareholder-returns><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>MSCI provides investment decision support tools and solutions for institutional investors globally. Their products include indices, portfolio construction software, ESG solutions, and private asset ...</p>\n\n<a href=\"https://seekingalpha.com/article/4716157-msci-how-the-customer-is-always-right-leads-to-shareholder-returns\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"URTH","symbol_name":"iShares MSCI World Index Fund","start_time":0,"source_url":"https://seekingalpha.com/article/4716157-msci-how-the-customer-is-always-right-leads-to-shareholder-returns","article_id":"2461382916","we_media_id":null,"thumbnails":["https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1363842522/image_1363842522.jpg"],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2461382916","pubTimestamp":1724244566,"sourceInfo":{"source_id":"seekingalpha","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"MSCI provides investment decision support tools and solutions for institutional investors globally. 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Their products include indices, portfolio construction software, ESG solutions, and private asset data analysis.MSCI's revenues are leveraged to stock market capitalization levels, with a focus on integrated offerings and excellent service.MSCI's balance sheet has significant negative tangible book value, which I would understand as a vote of confidence from bondholders who are willing to hold unsecured notes in MSCI.MSCI knows that the customer is always right - no matter how controversial, self-contradictory, or ineffective the customers' desires happen to be. Happy customers lead to good profit.MSCI, by an operating cash flow yield metric, is currently trading near an extreme high relative market valuation, but still has great long-term buy-and-hold prospects.   Jonathan KitchenBusiness Overview MSCI Inc. (NYSE:MSCI) is a premier provider of investment decision support tools and solutions for investors globally, in particular institutional investors. MSCI sells research and advisory services to enable their clients to understand and analyze drivers of risk and return in order to build portfolios whose key characteristics are better understood and more transparent. MSCI's products include indices, portfolio construction and management software tools, ESG & climate solutions, and private asset data and analysis. MSCI focuses on \"open and flexible\" technology, where its content and capacities are accessible to their clients via many channels and platforms. They aim to anticipate the needs and tastes of the investment industry and deeply understand their clients' needs, goals, and challenges. You will see later in this article just how far MSCI will go to please their customers. MSCI competes based on its \"integrated\" approach to their offerings, excellent service, providing differentiated research, and delivering their solutions with cutting edge technological channels. MSCI's clients span the whole universe of the investment industry, from pension funds, to endowments, central banks, sovereign wealth funds, insurance companies, and family offices. It includes asset managers such as mutual funds, hedge funds, ETFs, REITs, insurance products, and private banking products. It includes financial intermediaries such as banks, exchanges, broker-dealers, trust companies, custodians, fund administrators, and investment consultants, wealth managers, real estate professionals, and corporations. As of Dec 31, 2023, MSCI had about 7,000 clients in over 95 countries. BlackRock was its largest customer, accounting for 9.8% of total operating revenues, with 95.4% of those revenues being fees based on assets managed under MSCI's guidance by its indices, in ETFs and non-ETF funds. MSCI's business model charges about 0.02% to 0.04% fee on assets managed according to their indices and advisory services. As of 2023, over $13 trillion USD of assets were managed according to their research services. This means that MSCI's revenues are leveraged to the levels of stock market capitalization. MSCI's Business Segments MSCI operates under 4 segments: Indices, Analytics, ESG & Climate, and Other - Private Assets. Indices MSCI's clients use their indices to develop indexed financial products, especially ETFs, mutual funds, futures, options, annuities, etc., and for portfolio benchmarking, portfolio design & management, and asset allocation. MSCI calculates over 290,000 indices on a daily basis, and 16,000 in real time. Here are some of the MSCI-advised funds that you might have encountered in your own search for investment vehicles for your savings:   iShares MSCI World ETF iShares MSCI USA Value Factor ETF   iShares MSCI Emerging Markets ETF iShares MSCI USA Quality Factor ETF   iShares MSCI EAFE ETF iShares MSCI USA Momentum Factor ETF   iShares MSCI India ETF iShares MSCI USA Size Factor ETF   iShares MSCI ACWI ETF iShares MSCI USA Min Vol Factor ETF   iShares MSCI World UCITS ETF iShares MSCI EAFE Min Vol Factor ETF   iShares MSCI USA Quality Dividend ESG UCITS ETF iShares MSCI Emerging Markets Min Vol ETF   Click to enlarge As you can see, there are themes going on in their product offerings - funds organized by geography, investment factors, and minimum volatility portfolios. MSCI's research powers these funds that give retail investors access to well-researched character & factor tilts in their portfolios. For the year ended Dec 31, 3023, indices accounted for 57.4% of MSCI's revenues, the majority of which are annual and recurring subscriptions. Some revenues are calculated on their clients' AUM or trading volume. Asset-based fees were 38.4% of total revenues for this segment. Analytics The Analytics segment offers portfolio management, performance attribution, and risk management content, as well as applications and services that provide clients with holistic and integrated understandings of risk & return. MSCI also provides tools for analyzing market, credit, liquidity, counterparty and climate risk for major asset categories for all time horizons. Tools and capabilities include models to support factor-based analytics, single security analytics and pricing models, stress tests, portfolio optimization and liquidity risk analytics, performance attribution, as well as interest rate and credit curves. Clients access the Analytics tools using proprietary APIs and third-party applications. In 2023, a total of 24.4% of revenues came from the Analytics segment. ESG & Climate Recently, environment, sustainability and governance have become priorities in various industries. This segment provides products and services to help institutional investors understand how sustainability issues can affect the long-term risk and return characteristics of their portfolios, as well as at the individual security level. This segment was responsible for 11.4% of total revenues during 2023. Other - Private Assets This segment's offerings include data & analytics for private assets, allowing investors to understand fundamental information, measure & compare performance, understand exposures, manage risk, and conduct robustness analyses. MSCI also integrates their private assets' data & analytics into other MSCI products, including indices, climate risk models, and MAC models. Their offerings include:  Real Assets category: Real Capital Analytics, Portfolio Performance Insights, Portfolio Climate Insights, Portfolio Income Insights, Index Intel, and Property Intel. Private Capital Solutions category: Private Capital Portfolio Management Platform, Caissa Total Plan Platform, Transparency Data, and Universe Analytics.  This segment was responsible for 6.9% of total revenues in 2023. MSCI's Growth & Share Performance MSCI grows by both growing its market share of assets under its advisory, as well as by acquiring smaller firms to complement and expand their offerings. Here's a very brief list of their past acquisitions:  2010: RiskMetrics Group  2012: Investment Property Databank  2013: Investor Force  2014: GMI Ratings  2019: Carbon Delta  2021: Real Capital Analytics  2023: Burgiss Group   Below is a plot of MSCI's shares' total return level, which starts in Nov 2007 with shares priced at ~$25 each. Data by YChartsMSCI shares suffered during the subprime financial crisis in 2007 - 2008, but quickly recovered and went on to post a total return that would make each share produce $616.98 of value today. That is a total return rate of 21% annualized CAGR, which handily beats the S&P 500 over the same period. The Customer Is Always Right It is important to understand MSCI as providing products based on reading the desires of the investment community, providing the supply to satisfy popular demand. MSCI is the master of understanding that \"the customer is always right\", and supplies the desired services to its customers, no matter how much controversy there is surrounding its effectiveness and spectrum of outcomes of what the customer wants. Let's see this in action. International Diversification We can see this if we just plot the returns of BlackRock iShares funds that license MSCI indices along with the S&P 500: Data by YChartsIt is clear that while in the short run international markets and indices are correlated with each other because their volatility moves largely in parallel, in the long run they are wildly different in their rate of return: the US market having the highest (magenta line above) return. My personal understanding is that US markets have better returns because the US has a more flexible less regulated labor market, attracts entrepreneurial talent from all parts of the world, has the most developed capital markets, has the largest domestic market of consumers, has a highly business-friendly law system, and other factors that allow US companies to be the most rapidly growing and profitable in the world. So why then is there demand by US investors for international diversification? I believe that part of it is due to thought leadership by academia and leading industry practitioners. For example, the two papers linked below by AQR Capital, a highly respected hedge fund whose leaders are academic descendants of professors Eugene Fama and Kenneth French:   International Diversification Works (Eventually) - concludes that: \"Diversification protects investors against the adverse effects of holding concentrated positions in countries with poor long-term economic performance. Over longer horizons, underlying economic growth matters more than short-lived panics with respect to returns, and international diversification does an excellent job of protecting investors.\"  International Diversification—Still Not Crazy after All These Years - concludes that \"International diversification has hurt US-based investors for over 30 years [yikes], but the long-run case for it remains relevant [really?]. Both financial theory and common-sense favor international diversification, which is buttressed by empirical evidence that is very supportive at longer horizons and for active strategies. Finally, it would be dangerous to extrapolate the post-1990 outperformance of US equities, as it mainly reflects rising relative valuations. If anything, the current richness of US equities may point to prospective underperformance.\"  In particular, the previous paper mentioned has a rather damning citation inside it: Dimson, Marsh and Staunton’s (2022) annual dataset estimates that US markets outperformed non-US ones by about 2% from 1900 through 2021. This 2% might seem small, but because of exponential growth, over 10 years an investment that grows 2% faster is worth 21.9% more, over 20 years is worth 48.6% more, and over 30 years is worth 81.1% more, and so on. Even though to my mind, it is clear that international markets are correlated in the short run but differ in their long run returns by differences in institutions, resulting in the US market outperforming all other markets makes a very easy argument that individual investors in the US are better off solely investing in the US markets, there is strong thought leadership support for the opposite conclusion, as exampled above. Reasons for what in my view this an upside-down conclusion include:   A globally diversified portfolio does \"less worse\" than a US only portfolio during a market crash. My objection is that knowing the US market's long term higher return and its reasons should be sufficient to feed the discipline needed to sit through a given world market crash.  The past 30 years of US outperformance compared to the EAFE is driven largely by rising P/E valuations. This handily ignores the fact that earlier in their work, they state that US stock market outperformance is attributable largely to more quickly rising dividends. The catch is that in \"factor\" investing terms, investments that grow their dividends more quickly tend to score better on the \"quality\" factor, which typically means higher returns on equity and more earnings stability. In other words, it links right back to the reasons I stated for US stock market outperformance relative to the world.  Because of this thought leadership, there is broad market demand for ways to access international stock markets anyway. The success of the iShares international markets funds run according to MSCI indices can be seen below:   Fund Market Capitalization Expense Ratio   iShares MSCI World ETF (URTH) $3.6 billion USD 0.24%   iShares Core MSCI Emerging Markets ETF (IEMG) $80.0 billion USD 0.09%   iShares MSCI EAFE ETF (EFA) $56.0 billion USD 0.33%   iShares MSCI India ETF (INDA) $11.2 billion USD 0.65%   iShares MSCI Japan ETF (EWJ) $15.8 billion USD 0.50%   Click to enlarge To be clear, I'm not against the idea of holding foreign stocks - they can be great investments if evaluated on an individual basis, just like US domestic stocks. I just disagree with the idea with diversifying into foreign stocks by buying the whole index. Note in particular the very low expense ratio for the emerging markets ETF, at 0.09%, which gives investors access to otherwise very difficult-to-reach markets for a rock bottom price. Personally speaking, I'd avoid this fund because US publicly traded companies are stronger on average for good reasons, but because the market wants it, MSCI will supply it. Factor Investing This is going to gloss over a lot of technical detail. If you are so inclined to do the deep digging on this, I would recommend that you read this Wiki page first, and then Eugene Fama & Kenneth French's 3-Factor highly popular paper linked here. In short, \"factor\" analysis of stock market returns began after the Capital Asset Pricing Model was invented that described investment returns in terms of the parameter beta and the market's excess returns to treasury bills (or \"Market\") according to a single linear regression analysis. This is standard MBA material. But subsequently, it was found to suffer from numerous \"anomalies\" that made the model not fit well. The CAPM model was subsequently expanded into the 3-Factor model by Fama & French to include the covariates \"Value\" and \"Size\", and it was found that the trio of \"Market\", \"Value\", and \"Size\" could describe 90% of returns of diversified portfolios. More factors were subsequently added to the model. \"Momentum\" was added in 1994 by Carhart. Fama & French expanded their model to a 5-Factor model that included \"Investment\" and \"Profitability\" in this paper from 2014. Then AQR Capital incorporated the low volatility anomaly as the covariate \"Betting Against Beta\" in this paper, and subsequently a catch-all factor called \"Quality\" that attempts to capture desirable fundamental qualities of companies in this paper. In all, there are 300+ factors floating around in academic literature, but these I've listed here are the most prominently well known and researched factors. Clearly, there has been a lot of high quality academic work here that has attempted to dissect how stock market returns can be described in terms of factors in multiple linear regression models. Again, you can see the previously mentioned theme of thought leadership showing up: the market wants access to invest in these \"factors\". There's a catch. These factors were never designed to help investors earn higher returns - they are academic constructions designed only to be used to dissect and study returns. I know of just two iShares MSCI factor funds that have \"beaten\" the S&P 500, (QUAL) and (OTC:MUTM), which beat the S&P 500 (VOO) only by the tiniest of margins: Data by YChartsWhat's the catch? These funds don't actually \"invest in\" a factor, but rather pick stocks so that the overall portfolio is tilted towards that factor, using long-only portfolios. The original academic factors are actually computed using self-financing long-short portfolios that are rebalanced and reconstituted each month according to a formula. Because these portfolios are self-financing, they can't actually exist in real life - no broker would let you build a long-short portfolio with zero initial equity. Additionally, the constant rebalancing and reconstitution each month would incur enormous trading fees. However, \"factors\" even in the abstract are problematic in other ways too:  It has long been observed that the \"value\" factor is \"dead\": one theory by O'Shaughnessy Capital Management is that value factor is dead during technological revolutions, when new companies in the nascent industries are in their \"growth\" phase, and old companies from the previous revolution are in a \"value\" phase. Another theory by AQR Capital states that by almost any metric, \"value\" strategies are very cheap: because investors today are simply paying more for loved stocks than hated stocks in a highly diversified way. There doesn't seem to be agreement between these two authorities. The \"size\" effect has also been observed to disappear since the early 1980s. This note by Cliff Asness from AQR Capital states that early work on the size effect overestimated it because of the time period limitations in the databases used, and due to liquidity differences. Another note by AQR showed that the size effect appears only if you remove \"junk\" stocks from the sample, however \"junk\" is defined. On the other hand, a highly cited paper states that the size premium has been active in the US all along. The thought leaders vehemently disagree about the size factor. While the \"momentum\" factor was seen as very strong in early studies, a more recent study showed that controlling for time-varying factor exposure causes the momentum factor to largely disappear. Even BlackRock agrees that factors (including momentum) are cyclical and periodically underperform. So why should one tilt a whole portfolio to catch a hypothetical advantage that is fleeting? The quality factor is problematic for its difficulty of definition. The original AQR paper on quality minus junk defines \"quality\" based on a smorgasbord of characteristics in a weighted average z-score system. Clearly there should be many, many ways to define a \"quality\" factor, and there is no agreed upon method. MSCI's construction (method not shown) depends on return on equity, debt to equity, and earnings variability. The excerpt below shows AQR's construction, a very elaborate affair:  Quality Minus Junk, by Clifford S. Asness & Andrea Frazzini & Lasse Heje PedersenAQR published a paper that concluded that factor timing is hard - that is, it is very hard to predict when a factor will start to perform in order to try to capture it by constructing a portfolio tilted towards it. This seems to mean that a factor tilted portfolio, if it outperforms because its factors suddenly become active, outperforms because of luck. But despite all of this (and more) because the market really wants a way to get exposure to \"factors\", MSCI supplies the indices and licenses them to BlackRock to use to construct the factor ETFs. And it has done so quite spectacularly successfully, in my opinion, if we judge by the market capitalizations and expense ratios:   Fund Market Capitalization Expense Ratio   iShares MSCI USA Min Vol Factor ETF (USMV) $25.0 billion 0.15%   iShares MSCI USA Momentum Factor ETF (MTUM) $9.9 billion 0.15%   iShares MSCI USA Quality Factor ETF (QUAL) $48.1 billion 0.15%   iShares MSCI USA Value Factor ETF (VLUE) $6.8 billion 0.15%   iShares MSCI USA Size Factor ETF (SIZE) $0.3 billion 0.15%   Click to enlarge For the modest price of 0.15% per year, barely higher than the expense ratio of a Vanguard index fund, you too can get factor exposure if you want. Starting to see a theme here? It's that MSCI is highly effective at constructing implementable indices that end users can invest in via ETFs - highly effective at satisfying market demand, regardless of how controversial or well-supported the object in demand really is. Fixed Income At this point, I think you get the pattern: since the market wants it, MSCI will supply it so that the end product has a very low expense ratio, regardless of whether the investment is worthwhile or not. As of the writing of this article, MSCI has a total of 68 fixed income indices, representing the gamut of combinations of descriptors possible on an index of bonds. So far, I've analyzed a small sampling of MSCI's indices offerings that represent ~57% of MSCI's revenues as of 2023. Next, let's move on to ESG, which represents ~11% of MSCI's revenues as of 2023. Environmental, Social & Governance This starts off simple but becomes murky quickly. Simply put, there is demand on the market for \"good\" investing that allocates capital in companies that are good environmentally, socially, and governmentally. This demand is not trivial - it is very much mainstream: 22 December 2022 - Asset managers globally are expected to increase their ESG-related assets under management (AUM) to US$33.9tn by 2026, from US$18.4tn in 2021. With a projected compound annual growth rate (CAGR) of 12.9%, ESG assets are on pace to constitute 21.5% of total global AuM in less than 5 years. MSCI has quickly filled that demand with its offerings of ESG ratings, that rates securities on a very easy-to-understand AAA to CCC scale based on how \"good\" they are in satisfying ESG requirements. It all sounds great on paper. But. Let's list the controversies and things that require contortionist rationalizations. Let's begin with Professor Aswath Damodaran of NYU Stern, nicknamed the \"Dean of Valuation\". In quite straightforward terms, he calls ESG a \"feel good scam\". His first argument against the idea that ESG is useful is that all the outperformance of ESG funds in the last decade can be attributed to the outperformance of tech stocks, and so it's not obvious that ESG by itself means anything about investment returns. He also notes that those trying to sell ESG realized that behaving \"good\" doesn't sell, and they tried to tie ESG scores with investment returns. Instead, he argues that this makes no sense and that funds that constrain themselves with ESG standards should expect lower returns on average: If an asset is less risky, it should have lower expected returns. Thus advocates who argue that improving ESG will make firms less risky are directly contradicting other claims that investors will earn higher returns if they invest in high ESG companies. Adding an ESG constraint to investing will lower expected returns, with the only question being how much, leaving fund managers who have fallen for its charms in a fiduciary bind. Additionally, ESG has given rise to some apparent absurdities. For example, in the UK stock market, various \"sin\" stocks such as oil and gas, alcohol, tobacco, mining, defence and gambling sectors have achieved higher than average ESG scores: These stocks – Shell, Diageo, BP, Rio Tinto, BAT, Glencore, Anglo American, BAE Systems, Imperial Brands and Flutter Entertainment – have a higher average ESG score than the FTSE100 as a whole, according to one leading ESG data provider, Refinitiv. There are problems with the S&P 500 ESG index too: it weights companies based on relative ESG scores, meaning that a polluting company such as Exxon Mobil (XOM) could belong in the index if its energy industry peers have worse scores than it does. I have my own pet criticism of ESG too. Suppose that out of ESG concern I refuse to buy a share of a tobacco company. Then logically, that tobacco share has to remain in someone else's portfolio. Then, regardless of whose portfolio the tobacco share is in, the underlying company is still in business, selling tobacco to the same smokers anyway. This whole ESG exercise has been an exercise in virtue signalling. My refusal to buy a tobacco share has made no real-world impact at all. Despite all these problematic aspects of ESG investing, MSCI has masterfully supplied the market with ESG ratings for various stocks and funds because the customer is always right. Did you notice that every BlackRock fund comes with an ESG rating, and a very detailed breakdown of its exposure to bad assets? For example, (USMV) has the following very formidable and official-looking description on its home page on the BlackRock website, all of it supplied by MSCI: iShares Website - USMVWhether or not you choose to buy a share of USMV, its underlying \"bad\" companies remain in business, harming the world all the same. Analytics Finally, we come to analytics. Having discussed the fashionable market demand for international diversification, fuzziness and futility of factors as an investment tool, and the ineffectiveness of ESG, here MSCI seals the deal by packaging them in wonderful neat software applications that its clients can use to analyze their holdings. Unfortunately, I am not an asset manager at an institution that has a contract with MSCI for analytics software, so I am not able to supply my own screenshots of what this software looks like. This is because MSCI regards its software and analytics tools as proprietary. However, I can trawl the MSCI website for snippets that the end user sees: This first example is of a \"factor box\", that is powered by the proprietary MSCI FaCS, that analyzes portfolios and reports their factor exposures in a way that does not require any understanding of the statistical machinery they are based on (hence very beginner-friendly): MSCI FaCS and MSCI Factor BoxWhat do \"underweight\" and \"overweight\" really mean in terms of the multiple linear regression machinery the factor weights come from? Anyway, the picture above came from this document. I would like to note that factors don't have to always deliver outperformance - factors can at times be negative numbers, and exposure to a factor that is negative leads to a drain on returns. But that's beside the point of this very beginner-friendly way of presenting factor analysis that doesn't mention the multiple linear regression at all. MSCI is truly masterful at making its customers happy. I don't go out of my way to nitpick everything I see. For another example of MSCI's analytics at work, we can see MSCI Corporate and Sovereign Issuer Curves: MSCI Corporate and Sovereign Issuer CurvesHere we see a straightforward visualization automatically generated by MSCI's software of a yield curve for Russian sovereign debt, based on a few issues and their weights. Again, we see MSCI's masterful use of graphical interface to hide the computational machinery that goes into mathematically fitting a yield curve - it looks sleek, looks about right, and requires no mathematical effort on the part of the end user. The result is a happy customer. Next, let's look at MSCI's public climate research tools. You can search any company by ticker or name, and MSCI will give you its report on that company. For example, below, I chose to research Exxon Mobil: MSCI ESG Ratings & Climate Search ToolThis is all in MSCI's style: pastel-coloured icon graphics, sleek graphs, and colour coding. And the result is a very good-looking panel of seemingly easy to understand metrics, which are again very customer-friendly. We know that Exxon Mobil is an oil company, and we got the expected result: Exxon Mobil is not aligned with the needs of the global climate. But there are some odd-looking metrics here. What is the MSCI Implied Temperature rise? Why does Exxon Mobil get its own score? Isn't global warming the outcome of the collective actions of humanity, and not just any one company? If this score is for Exxon Mobil alone, then does it mean that if Exxon Mobil stopped producing oil & gas, the world's temperature would be 3.2C lower? Also, whose carbon budget does the graph talk about? Is it the world's carbon budget, or just Exxon Mobil's budget? It doesn't make any sense to me. But it doesn't have to - it looks sleek and professional, and corporate customers will buy it. MSCI's Moat I think it's quite simple. MSCI is a master at selling tools to asset managers and decision makers in a way that hides all the technical detail and makes decision-making easy and sleek, while ignoring or brushing aside all the problematic aspects of what its customers are demanding. MSCI is simply fantastic at making corporate customers happy, and its end users feel smart. That is MSCI's real competitive advantage in its market. As a result of MSCI's ability to package complex and controversial demand items in a sleek and authoritative way, they have become known as a standard-setter in the industry, the second part of their moat. This is part of why I rate MSCI a \"buy\".   MSCI Has Excellent Financial Performance Income Statement Takeaways Below is a graph of MSCI's revenue, gross profit, operating income, and net income, plotted on a logarithmic scale. I chose a logarithmic scale so that exponential trends are represented as straight lines, and margins are represented as vertical distances between lines. Data by YChartsThis graph shows that each of revenue, gross profit, operating income, and net income are on exponential growth trends, with more volatility further back in the early 2010s. The lines becoming closer together over time means that profit margins have been steadily expanding, suggesting that MSCI possesses operating leverage - while the cost of creating and maintaining an investment index is fixed, the fee-generating assets managed under it are certainly not fixed. As of the most recent quarter, MSCI's gross margin was 82.09%, its operating margin was 53.50%, and its net profit margin was 43.88%. MSCI is a highly, highly profitable company. Balance Sheet Takeaways Next, let's look at some key lines on MSCI's balance sheet. Let's begin with the assets: Data by YChartsThis is a rather busy graph, so I'll unpack it line by line. The first thing to notice about MSCI is that Property, Plant & Equipment (net of depreciation) is a miniscule portion of MSCI's total assets. MSCI is an asset light business that does not use many tangible assets for its operations - if you think about it, a research firm operates computers and brains, not scaffolding and steel. This means that organic growth for MSCI is very easy: all it has to do is buy more computing power, hire more workers, and lease some more office space. The rest of MSCI's balance sheet is dominated by goodwill & intangibles, and current assets, especially cash & cash equivalents. MSCI has a LOT of goodwill and intangibles because of the nature of the businesses it has acquired in its recent past: it has grown by acquiring other ratings, database, and software companies, which are all asset light, so that the majority of the purchase price of those acquisition targets is assigned to goodwill, with only a tiny portion of it actually paying for the physical assets. Next, let's peek at MSCI's liabilities: Data by YChartsThere's not much to say about its balance sheet liabilities, except that it's dominated by long-term debt. Long-term debt consistently rose when interest rates were low, and then it stopped rising in 2022 when interest rates rose - management is opportunistic about employing debt. Here's a breakdown of its long-term debt, and note the low coupon rates: MSCI Q2 2024 10-Q FilingHowever, this does raise the question of what will happen further down the road: will MSCI pay down the debt in cash, or will it refinance it by issuing new senior notes at a higher rate? This question becomes relevant starting in 2029 when the first senior note matures. I believe that management's decision at this juncture will tell us how management truly thinks: a long-term thinking management would pay down the debt as it comes due, and put off share buybacks because if this debt is repaid by issuing more debt, the prevailing interest rate will most likely be higher. I would value long-term debt minimization over short-term share buybacks. Next, let's take a look at MSCI's overall leverage levels: Data by YChartsMSCI's total liabilities exceed its total assets by $734.5 million, and if we strip out the goodwill and intangibles, its tangible book value becomes a whopping negative $4.59 billion. It means that bondholders are so confident of MSCI's strength as a going concern (because its business model is so resilient) that they were willing to let MSCI borrow until its tangible book value is deep in the red. So as a potential investor in the stock, I'll take it as a vote of confidence from the bondholders. Cash Flow Statement Takeaways Below are MSCI's operating cash flows, capital expenditures, stock buybacks, and net debt issuance plotted together. The graph is rather busy, so I'll break it down line by line. Data by YChartsMSCI has been growing as a business, and so its operating cash flows, represented in purple, have expanded dramatically. Capital expenditures are represented in orange, and this quantity is very small, in line with MSCI's status as an asset light operation. Sandwiched in between are stock buybacks and net debt issuance: it appears to me as though MSCI has gotten into the habit of using debt issuance to at least partially fund its stock buybacks. While it does boost share prices in the short run, it does mortgage MSCI's future cash flows to grab that easy one-time boost in share prices. Overall, the three financial statement data paint a picture of a rapidly growing, resilient business that requires little tangible assets to operate, that bondholders are happy to lend to until it has a negative tangible book value, and that is happily engaging in massive share buybacks.   Market Valuation Of MSCI Shares Let's look at MSCI's market valuation via its P/E ratio: Data by YChartsMSCI has historically traded at about 25x - 50x earnings, except for the COVID pandemic period, when its earnings fell and caused its P/E ratio to spike. It currently trades at 37.57x P/E, and so I would consider MSCI to be trading at a historically average valuation right now. Next, let's look at the operating cash flow yield: Data by YChartsMSCI has historically traded at anywhere between 2.0% and 9.0% operating cash flow yield. Note that under this metric, a high operating cash flow yield indicates a lower market valuation. MSCI currently trades at 3.5% operating cash flow yield, which means that under this metric, MSCI is currently trading near an extreme high market valuation ratio. On the whole, I'd consider MSCI to be slightly overvalued right now. However, if you're a long-term investor who believes in the mantra \"time in the market matters more than timing the market\", and you know that MSCI's returns are tied to overall capitalization of the stock market (and it's historically gone up on average), then maybe you would care less that it may be marginally overvalued right at this moment. For that reason, I rate MSCI a \"buy\". Risks & Exposures Of MSCI I've perused MSCI's 2023 10-K filing for risks, and attempted to select and explain the most pertinent and salient risks listed. To see a complete list of risks, I would refer you to read the 10-K filing yourself. MSCI is exposed to possible reputational and credibility damage. Factors such as conflicts of interest, the adequacy, completeness & editorial independence of their index products, and questions about the ESG rating & assessment methods could cause reputational harm. Other sources of risk include influence or appearance of influence of MSCI by third parties, the timing and nature of changes to their index products, disagreements about the methods for computing their indices, and views expressed by the media, politicians, and other government officials and regulators could also have impacts. It is possible that clients that pay a variable license fee (based on assets under management or trading volumes or expense ratio) could seek to negotiate a further reduced fee structure for their licenses, which could reduce MSCI's total revenues. However, I doubt that this is likely, since MSCI's fees are already quite small, amounting to 0.02 - 0.04% of assets under management, which compares very favorably with the fee structures of major index funds. MSCI's fees are present, but probably unnoticeably small by the average investor on returns provided by MSCI-advised funds. MSCI's clients may become more self-sufficient, in that they would seek and succeed at developing their own indices to use to manage and benchmark their own funds. This would reduce demand for MSCI's services and materially reduce their revenues. Combined with the fact that MSCI has some rather large clients - BlackRock representing 9.8% of total revenues in 2023 - the risk becomes further amplified. MSCI uses open source code to help develop its products, which do not have warrantees and may be riskier to use than third party commercial software. Some open source code license stipulate that if MSCI combines its proprietary code with the open source code and distributes it in certain ways, MSCI would have to release its proprietary code to the public.  MSCI is currently working to incorporate AI solutions into its offerings, which in the future may become more and more important. Since AI is in its infancy and is constantly changing, and its reliability is not guaranteed, it is possible that MSCI may fail to compete with its competitors to introduce AI adequately, or that the AI might occasionally malfunction or fail to produce accurate results. Additionally, laws and regulation around the use of AI are in their infancy too, which creates operational uncertainty in the near term.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2461382916"}