MSCI Inc (MSCI) — Q4 2020 Earnings Call Transcript

Thank you, operator. Good day, and welcome to the MSCI Fourth Quarter 2020 Earnings Conference Call. Earlier this morning, we issued a press release announcing our results for the fourth quarter 2020. This press release, along with an earnings presentation we will reference on this call, as well as a brief quarterly update, are available on our website, msci.com, under the Investor Relations tab. Let me remind you that this call contains forward-looking statements. You are 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 disclaimer in our most recent Form 10-K and in our other SEC filings. During today's call, in addition to results presented on the basis of U.S. GAAP, we will also refer to non-GAAP measures, including, but not limited to, organic operating revenue growth rates, 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 insight into our core operating performance. 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 in the appendix of the earnings presentation. We will also discuss run rate, which estimates at a particular point in time the annualized value of the recurring revenues under our client agreements for the next 12 months, subject to a variety of adjustments and exclusions that we detail in our SEC filings. As a result of those adjustments and exclusions, the actual amount of recurring revenues we will realize over the following 12 months will differ from run rate. We, therefore, caution you not to place undue reliance on run rate to estimate or forecast recurring revenues. Additionally, we will discuss organic run rate growth figures, which exclude the impact of changes in foreign currency and the impact of any acquisitions or divestitures. On the call today are Henry Fernandez, our Chairman and CEO; Baer Pettit, our President and COO; and Andy Wiechmann, our Chief Financial Officer. With that, let me now turn the call over to Henry Fernandez. Henry?

Thank you, Salli. Hello, everyone, and thank you for joining us today. MSCI continues to deliver on its mission of helping investors build better portfolios for a better world. Our ultimate goal is to provide an index for every portfolio and tools for every investment decision worldwide. Especially in 2020, we continue to deliver mission-critical tools to enable clients to navigate uncertainty and respond to industry transformations resulting from the unprecedented environment. Our relentless focus on execution, our disciplined approach to investments and our strategic capital allocation underpin our ability to deliver value to our shareholders. MSCI's financial performance in the fourth quarter strongly validates this approach. We achieved total revenue growth of over 9% and total subscription run rate growth of nearly 11%, adjusted EBITDA growth of over 16% and adjusted EPS growth of over 17%. In 2020, we achieved free cash flow of $760 million, up 16% from 2019. We feel this was outstanding financial performance in the context of a very tumultuous year on so many fronts. Our success and our momentum have been driven by our ability to identify and capitalize on major transformations taking place in the investment industry and our ability to support our clients with critical insights, thought leadership, and actionable solutions. I will provide a few selected comments along the dimensions of clients, products, and capabilities, and Baer and Andy will then give you some more details. In the client category, we have been successful in expanding our footprint with both new and existing clients. In our strategic focus on wealth management, we are capitalizing on the focus of financial advisers on direct indexing, portfolio construction, risk and performance management, and ESG and climate. We're also seeing early traction with corporate clients, and we now have over 80 corporate clients for our ESG and climate offerings. We continue to expand our business with our established base of asset managers and asset owners. In 2020, our asset management clients launched more than 150 new ETFs linked to MSCI Indices, over half of which were linked to MSCI ESG and climate indices. Regionally, our integrated client approach has led to high levels of engagement and activity. In Europe, regulatory requirements for our clients helped drive record quarterly recurring subscription sales during the fourth quarter. In Asia, new subscription sales in the fourth quarter improved 62% sequentially after a very slow process during the year due to the early pandemic disruptions in the region. In the category of products and services, our product innovation is driven by our relentless focus on the needs of investors. One area of significant investor focus is the global transition to a low-carbon economy and its impact on portfolios. Our Climate Value-at-Risk products have seen excellent traction and are already helping investors measure and manage climate risk as well as identify investment opportunities. Fixed income is another area where we continue to enrich our offerings. We are leveraging our strong brand in ESG, climate factors, and risk and performance analytics to benefit our credit investor clients. Lastly, we continue to build critical capabilities, especially in technology and data. This includes accelerating the transition of our suite of products to the cloud through our partnership with Microsoft. We're also excited about enabling clients further with more seamless access to MSCI data across all product lines. You will be hearing more about this in future quarters, especially in ESG and climate. Another key ingredient of our strategy is allocating capital in a systematic and disciplined manner. This approach has been highly effective for us, including in a year like 2020. We activated our downturn playbook in the second quarter as the pandemic took hold and market volatility and economic uncertainty rose dramatically. Then in the third quarter, we transitioned efficiently to our upturn playbook as our business remained resilient, our financials were protected, and we saw expansion opportunities. It is also important to note that in 2020, our adaptable and entrepreneurial culture played a critical role in our success, especially given the major disruptions in our working environment and that of our clients. Following closely on the incredible momentum we have built in 2020, MSCI has never been better positioned to take advantage of accelerating secular and disruptive investment trends, which will allow us to deliver sustained and significant top-line growth. We remain deeply committed to investing responsibly in Triple-Crown opportunities to leverage and build on the established scale of our business. Our intention is to continue to drive long-term value for our shareholders. We're especially energized to talk further with you about our plans at our upcoming Investor Day on February 24. Before I turn the call over to Baer and Andy, I am pleased to announce that we will be reporting ESG and climate as a stand-alone reporting segment starting in the first quarter of this year. Our All Other segment will consist of our private assets, the private asset product line, including our Real Estate business. This incremental transparency will enhance awareness and understanding of these important growth areas for our company. You will have more insight into the drivers of segment growth, the actions that we are taking and the investments that we're making. Finally, we believe it's critical that we meaningfully integrate corporate responsibility principles into our own strategy and operations. We continue to enhance our processes and disclosures, including, most recently, publishing our 2020 TCFD report and FASB-aligned disclosures on data security, workforce diversity and engagement, and professional integrity. I look forward to providing you with further updates as we continue to make progress in these very important areas. With that, I'll now turn over the call to Baer.

Thank you, Henry, and greetings, everyone. I'll echo Henry's enthusiasm for the progress we've made this past year. We had our best-ever quarter for subscription sales across MSCI and in our Index and ESG segments individually. Assets in equity ETFs linked to MSCI Indexes passed the $1 trillion mark for the first time in our history. As of last Thursday, these assets reached further all-time highs, above $1.16 trillion. AUM and equity ETFs linked to MSCI ESG and climate indexes were at $106 billion at year-end, tripling year-over-year. And 7 of the 10 largest equity ESG ETFs globally are benchmarked to MSCI Indexes. We're pleased with these accomplishments and excited for the momentum we see in our business. I want to expand on some aspects of our strategy, starting with clients and client segments. Our key accounts, which represent nearly two-thirds of our run rate, drove 50% of new subscription sales this quarter. While in 2020, MSCI also gained more than 450 new clients. In ESG, new clients represented over 50% of new subscription sales this year. Henry noted our efforts with wealth management firms. We are pleased both with the progress of our sales in this segment and our early steps in new opportunities like direct indexing. Wealth management was the fastest-growing client segment for Analytics in 2020 with run rate up 11%, while index run rate grew at 20% and ESG research at over 70%. Our total run rate with wealth managers is now more than $60 million, up 23% from 2019. For corporates, we recently launched an interactive industry ESG materiality map on msci.com. This tool helps corporates better understand how various ESG risk exposures factor into their ESG ratings. More broadly, issuers and corporate advisory firms are leveraging our ESG ratings universe for use cases ranging from benchmarking to climate modeling. From a regional perspective, in EMEA, our 2020 subscription run rate growth was 15% as strong recurring sales offset cancels. In Asia and the Americas, we had 9% and 7% subscription run rate growth, respectively. A solid result for the year, especially acknowledging the challenges some of our clients faced during the pandemic. We are now seeing our pipeline build as we would expect at this time of the year. It remains healthy across products and regions and above pipeline levels at this time last year. As I've emphasized before, I've been eager to make innovation in our products and services central to what we do at MSCI. In October, we launched 8 MSCI Climate Paris Aligned Indexes. These indexes are designed to help investors incorporate climate change into their portfolios. They also help investors align their investment strategies with the 1.5-degree warming scenario targeted by the Paris Agreement. Henry mentioned the success we are seeing with our Climate Value-at-Risk products. We recently integrated Climate Value-at-Risk into Analytics products to support clients with their regulatory requirements, such as TCFD reporting. We also integrated Analytics portfolio optimization tools into our Climate Value-at-Risk products. Thus, climate analysis feeds our Analytics products and vice versa. Further in Analytics, during the fourth quarter, we launched Multi-Period Stress Testing capabilities. We're acutely aware that investors look at their positions through a lens of different time horizons, and we want to provide them with industry-leading tools to do so. We believe MSCI is truly differentiated in this regard as these capabilities leverage MSCI's market-leading multi-asset class factor models and stress testing tools. As you're aware, fixed income is another area of focus for MSCI. I'm pleased to note that we closed our first fixed income index subscription deal during the past quarter. This is an important milestone and a validation of our belief that this nascent product line has significant potential. We are also mapping our ESG ratings to bank loans, expanding our ESG ratings coverage of fixed income securities, and enhancing fixed income factor content for our risk and performance analytics. Our footprint in fixed income continues to grow with run rate in this area up 10% in 2020. Henry mentioned our focus on enhancing our data capabilities. Leveraging our partnership with Microsoft, we have made a great deal of progress with our API strategy in the fourth quarter. As one example, we are building accessibility to our ESG ratings and other ESG underlying data through APIs as well as through other state-of-the-art content delivery platforms. We must continue to support our clients' ever-evolving needs, lean into our own tremendous opportunities and drive sustained high levels of growth. MSCI will invest in several key areas in 2021. First, we will continue developing new innovative indexes and other tools that enable our clients to build portfolios that meet their investment objectives. Second, we will keep expanding the coverage of our ESG and climate ratings and capabilities, including the data initiatives I mentioned previously. And third, we will invest in our broader technology transformation and client-driven migration to a service platform. These investments will be executed within our rigorous Triple-Crown capital allocation framework. We intend to continue generating strong free cash flow. As Henry noted, we look forward to highlighting our opportunities, our investments, and the value creation we believe will result at our upcoming Investor Day event. Let me now turn the call over to Andy, who will discuss more specifics of the financial aspects of our performance.

Thanks, Baer, and hello to everyone on the call this morning. As Henry and Baer noted, we finished 2020 with a strong fourth quarter and significant momentum heading into 2021. In Index, we recorded double-digit subscription run rate growth for the 28th consecutive quarter. Market cap weighted modules, which represent the largest part of our index subscription run rate, continued to deliver strong growth of approximately 9% in the quarter; while our factor, ESG, custom, and specialized modules grew at healthy double-digit growth rates. From a client segment perspective, the index subscription run rate growth with asset managers, the largest client segment, was 9%; while growth rates among wealth managers, hedge funds, and asset owners were all greater than 15%. Assets under management and equity ETFs linked to MSCI indexes reached record levels, driven by strong cash inflows of $59 billion or close to 30% of all cash inflows into equity ETFs during the quarter. This was driven by strong market share capture of cash inflows across all geographic regions, particularly strength in emerging market exposures. Equity ETFs linked to MSCI ESG and climate indexes experienced cash inflows of nearly $25 billion during the quarter. These cash inflows represented nearly 80% of all inflows into ESG and climate ETFs. Overall, asset-based fee revenue was up over 15% year-on-year, reflecting higher results across the board, including from ETFs, non-ETF passive products, and futures and options. Turning now to our adjusted earnings per share growth year-over-year. Underlying business performance drove the vast majority of our growth in adjusted EPS, while our share repurchases also contributed. Operating revenue growth was strong, and year-over-year expenses were up modestly, benefiting from lower travel and entertainment expenses, which were lower than the fourth quarter of 2019 by $4.2 million, and somewhat offset by our reaccelerated pace of investments in the second half of 2020. Turning to our balance sheet. We continue to have strong liquidity that provides us tremendous flexibility. We finished the quarter with total debt to adjusted EBITDA of 3.5x, at the top end of our targeted range of 3 to 3.5x. Lower cash tax payments and disciplined client collections led to significant outperformance in our free cash flow generation in the fourth quarter relative to our guidance. As Henry noted earlier, we have been pleased with the success of our capital management strategy, and we'll continue our disciplined and patient approach to allocating capital. We are keenly focused on reinvesting in the business as a first priority, optimizing our leverage profile to enhance returns and maintain flexibility, providing a consistent quarterly dividend that grows with earnings, and is based on a payout ratio of 40% to 50% of adjusted EPS. We aim to opportunistically pursue M&A and share repurchases with an intense focus on maximizing returns to shareholders and preserving a strong liquidity position. As Henry noted, to enhance shareholder awareness and understanding of our progress in pursuing key growth opportunities in ESG and climate and in private assets, starting this year, we will present ESG and climate as its own reporting segments and All Other will consist of operating segments and private assets. Beginning in April, when we report Q1 earnings, you will see the same financial and operating metrics we currently show for the Index and Analytics segments, also for the ESG and Climate segment and for Real Estate. So that you have historical information for comparative purposes, we will provide information for the new reporting segment annually for 2018 and 2019, and quarterly for 2020. Revenue and operating metrics from ESG and Climate indexes will remain within our Index segment. We are excited to bring this incremental transparency to our disclosures and to continue to update you on these exciting areas of growth and opportunity. Before I turn to guidance, I would like to highlight that recurring subscription revenue has lagged subscription run rate by a slightly larger amount in the last couple of quarters. As noted in our disclosures, there are several factors that can contribute to this, including, but not limited to, the timing of sales and cancels; modifications; FX movements; delayed contract start dates, also known as advanced bookings; and implementation periods. In response to the COVID pandemic, we have selectively used advanced bookings recently to help drive new business in key areas. When these are offered, the client is contractually committed to a subscription agreement, but may have access to the service prior to the beginning of the fee period at no cost. In these cases, the sale may be recognized before we begin recognizing revenue, or we may recognize a lower amount of revenue in the first year relative to the size of the sale. We used these tools selectively this past year. And while we do intend to continue to use them going forward, we don't expect the magnitude to increase materially. However, as we said at the top of the call, we would caution you not to place undue reliance on run rate to estimate or forecast recurring revenues. Turning to our guidance. Our expectations for 2021 reflect what we believe will be another strong year for MSCI with several guiding principles. Our expense guidance assumes relatively flat equity market levels for the year. As such, our expenses may flex up and down depending on market conditions and the trajectory of our asset-based fees. To that end, we will continue to implement our upturn and downturn playbooks if and when they are needed. As we've noted throughout this call, investing in our business remains our top priority. However, we are also committed to delivering positive operating leverage, although you should expect to see more modest margin expansion than in the recent past. Our free cash flow guidance reflects strong operating performance and strong collections; relatively flat market levels, although we could, of course, see markets perform better or worse; margin expansion over the course of the year, again, likely at a more modest pace than in the recent past; and higher cash taxes in 2021. In summary, 2020 was a very strong year for MSCI despite the global hardship related to the pandemic. We have continued to deliver innovative indexes, research, data and other tools. We've executed against our strategic priorities, staying incredibly productive and engaged as a team. And as always, we remain committed to driving further value for our shareholders. We look forward to speaking with you in a few weeks at Investor Day. And with that, operator, please open the line for questions.

Looking at the expense guidance, you're expecting about a 9% increase in expenses for the year, which is typical for you, but it's compared to a year where expenses were not increased at all. Running through the model, it appears you could possibly expand EBITDA margins by about 100 basis points from a year where margins were unusually high due to COVID-related savings, such as reduced travel. My question is, why not invest more in the business to support growth? Is this cautious approach because we may not be fully past COVID yet, or do you see these COVID-related savings as sustainable? Additionally, as we look through the year, should we anticipate more of a margin increase in the first half compared to the latter half, where some of the COVID-related benefits might return?

That's a great question, Toni. It goes to the core of what we aim to achieve at MSCI, which is balancing the maintenance and enhancement of our margin levels, even if modestly, while heavily investing in key growth areas that our clients urgently need new tools for. This includes the increasing focus on climate change, overall ESG requirements, the soaring demand for indices linked to specific investment theses, the need for better understanding of portfolio risks—especially factor risks related to shifts from value to growth or cyclical to growth investing—and the growing interest in private asset classes. We are currently experiencing significant demand from both our existing clients and new client segments we're reaching, such as wealth management, corporate entities, and insurance companies, for more tools from MSCI. Now, let me hand it over to Andy to provide further insight into how all of this influences the dynamics of EBITDA growth.

Yes. Thanks, Henry. And good question, Toni. Maybe if I can provide a little bit more color from a financial standpoint and underscore some of the points that you've made and Henry made. We are coming off a year, as you said, where expenses were lower than we anticipated. They were brought down by COVID-related impacts like T&E being lower. We also very actively went to the downturn playbook in the middle of the year, and the ABF rebounded faster than we were able to begin reinvesting in the business when we went back to the upturn playbook. So that did depress the expense base in 2020. To your point, if you look back to 2019 and extrapolate through to what our guidance is for 2021, you'll see there's a more normalized trajectory across the two years. Looking forward and taking into consideration a couple of factors that set into our guidance, firstly, there will be some rebound in T&E and COVID-related costs, but we don't anticipate it will be a full normalization. So there will be some continued benefit going forward. And obviously, that can change and adjust depending on how the pandemic unfolds here and we return to the pace with which we return to a normalized working environment. The other thing that is important to remember here is, as I mentioned in my opening remarks, our guidance assumes markets remain relatively flat. And so we've put an expense guidance range here that assumes relatively flat market levels. If market levels do rebound significantly and show a sustained improvement or the markets increase significantly and show a sustained improvement, we will go to our upturn playbook, likely, and expenses could be higher. Similarly, we could see, if the markets pull back significantly for a sustained amount, we could be lower than the expense guidance. And so it could go either way. One of the things we wanted to do with the guidance this year was show you what the guidance is based on current market levels to give you the heads-up that it could change if they swing one way or the other. The other point of note, I would say, factors in here is there is some implicit FX pressure embedded in the expense growth as well, where the U.S. dollar has depreciated relative to most foreign currencies relative to average rates for 2020. And so that puts some pressure on the expense growth as well, and that's something we're keeping a close eye on. But I think overall, to Henry's point, we are extremely focused on continuing to invest in key initiatives and key investments that are going to continue to extend the duration and improve the trajectory of our growth profile going forward. And so that will be a top priority, and we will continue to calibrate it throughout the year.

Given the significance of this question, I want to add one more point. Recently, we have started analyzing EBITDA expenses in two main categories: those necessary for ongoing business operations and those that represent significant investments in growth areas. As an IT company, most of our investment is expensed immediately, while revenues typically materialize one, two, or even three years later. Therefore, we are focusing on minimizing operational EBITDA expenses to free up more capital for transformative investments. In rough terms, our investment-related business expenses currently represent a low to mid-teens percentage of total EBITDA expenses, and we aim to increase that to the mid- to high teens in 2021 and beyond. Ideally, within the next two to three years, this could reach the 20s, allowing a substantial portion of what are perceived as expenses to actually be investments. You can see the accelerated growth in various aspects of our business, particularly in ESG, futures and options, and fixed income, which are benefiting from investments made one, two, or three years ago.

Henry, let me just add one last point to make sure everyone's aware of, and I know most of you incorporate this into your models. But given the swings we saw both on the top line and the expense line in 2020 throughout the year, the expense growth and margin could fluctuate quarter to quarter throughout 2021, just given the relative comparisons year-over-year.

That's great. I wanted to also ask how important to you is or was the IHS partnership that you had? Is your expectation that they will not be working with you in the future because they've announced the combination with S&P? I know you were working with them on fixed income liquidity risk solutions and thinkFolio but maybe there were other areas, too. So can you outline what opportunities you were working on with them? And if those can be replicated by partnering with another provider like Bloomberg, for example?

That's a great question. At MSCI, we have a focused strategy centered around partnerships within the industry. Client partnerships are particularly impactful for those with varied data, technology, or distribution systems. We strongly believe in an open architecture system that benefits our clients, and we are committed to building partnerships across the board. Regarding our mergers and acquisitions, most of our efforts focus on what we refer to as mergers, partnerships, and acquisitions. One key relationship we have developed is with IHS Markit. In light of the merger between S&P Global and IHS Markit, I have spoken with the CEOs of both companies, and they plan to maintain and enhance our partnership, allowing us to develop joint products for our clients.

Maybe kind of a follow-up to that. But Henry, I was just wondering the way the markets have been pretty much just going up despite COVID. There's also been a lot of M&A around your areas of focus, ESG, data, generally speaking. How is that influencing or changing the way you look at your build versus buy decisions or even just your MP&A framework?

Good question, Manav. I believe our strategy remains unchanged. We are fortunate at MSCI to have numerous organic investment opportunities that provide impressive returns. This is due to our ability to build on existing infrastructure. We’ve seen this in Estate and Index and are starting to see it in ESG. In Analytics, we are still developing some capabilities, which means the returns are not as high as Index and ESG, but they still remain in the high double digits in terms of internal rates of return. Therefore, we are focused on organic investment and do not require any major acquisitions at this time to achieve our company goals. That said, we do evaluate every opportunity. We are increasing our efforts in small bolt-on acquisitions in data, tools, and technology, especially in fixed income and private asset classes. However, these will be smaller in nature, so we continue to prioritize organic investment. We also prefer this approach because we aim to do the opposite of what others are pursuing. We want to maintain a strong focus on our strategy, fostering an empowered and entrepreneurial culture that encourages innovation, better client interaction, and improved services. We do not want to become a large financial data conglomerate with many divisions managed by administrators. Instead, we aspire to have a highly integrated company led by entrepreneurs with high levels of innovation and investment, while also enhancing our margins. We believe this is the best strategy for us.

Got it. That makes sense. I appreciate that. Regarding the upcoming Investor Relations Day, you mentioned disclosures and so on. You have always provided a lot of insight. I was just wondering what the key agenda points will be for the upcoming Investor Relations Day that we should be looking forward to.

Well, not to steal any thunder from the 24th, so we can get everyone to show up, right? I think what you're going to see from us is a continued focus on the mission of the company, the strategy, the demand that we see from all the client segments and the needs from clients, therefore, the organic investment plan that is attributed to that, the integrated franchise between the different product lines and all of that. And I think the area that you will see even more change in this Investor Day is our incredible push into technology and data. In the past, we at MSCI have always thought of the investment tools first and technology and data enabling the investment tools. We want to start thinking the reverse. What can technology and data open up for us to create even more investment tools for the world? So there will be a segment on that as well.

This may be too detailed on the Analytics side. But I remember a few years ago, when you were still breaking out portfolio management and risk, there was a time that portfolio management was very weak and you cited quant funds as an area of weakness. There's been a lot of stories recently again how poor performance in quant has been in 2020, and this environment clearly doesn't work for them. So just curious, is a quant fund still a very big area for you guys? Maybe you can give us some updated numbers. And are you seeing weakness in that client segment?

Yes, Alex. I don't have the numbers at the moment. Sorry, there seems to be an echo on my line. Can you hear me?

Much better now.

I'm sorry, I don't have the specific numbers at the moment. However, generally speaking, when we analyze equity analytics and other enterprise risk elements, there haven't been any consistent patterns over time. Recently, we have seen significant growth in the contribution of factors to the Index business, particularly among larger quant funds, which are performing well despite being limited to a few big players. On the other hand, smaller hedge funds with diverse strategies continue to present challenges for analytics. Looking ahead, the distinction between quants and non-quants seems to have evolved, especially as newer clients increasingly integrate quant tools into traditional portfolio management. I’m not sure if you have specific numbers available, Andy, but we can certainly follow up later. Overall, I want to emphasize that there isn't a negative trend here; we’re not observing quants as being outliers, and our more advanced quant strategies are doing well.

Yes. No, I'd underscore that, Baer. I think from a retention standpoint, hedge funds are below average, and it's largely attributable to the smaller hedge funds. And as Baer said, we do have success selling and growing within a lot of the larger hedge funds across products that we offer. I'd say the one other segment, just to provide a little bit more color on retention and analytics, that we felt pressure in 2020 was around banks. And so we did have some, particularly one large cancel among a bank, which depressed the retention rate across Analytics.

Okay. Great. And then quickly, other topic. China is something that we keep on hearing about. And obviously, with some of the restrictions, there's been a lot of news around your index inclusions, et cetera, which I know this is normal course of business for you. But my more important part of this question is, how does this kind of impact your China strategy in general? I mean that region is obviously growing rapidly and opening up for financial market participants. So I think you definitely have your eye on that region. So does that noise create headwinds right now in being able to grow with potential clients in the region? And maybe you can remind us how big China is as well.

Yes. So we are neutral to any of these geopolitical issues that take place in the world. Our main focus is always to serve the needs of global investors to invest in all regions of the world, including, obviously, emerging markets, which are higher risk than other regions. We try to, therefore, stay away from all the politics and all the theatrics that take place there. Secondly, we continue to believe that China, as the current second largest economy in the world and the opening up of its financial markets, is going to present vast opportunities for investors in the public market and the private market. Obviously, equity investment is opening up dramatically. Bond investing, given the high yields here and the appreciation of renminbi, will continue to be a major attraction for bond investors, especially sovereign bond investors and the like. We are very focused on continuing to expand our business in China to grow our cross-border business, so to speak, between global investors going into China, our business of helping Chinese institutions invest outside of China and in the domestic markets of China as well, including Hong Kong. So our business is still small in the sort of $15 million to $20 million range, something like that, in terms of run rate coming directly from China. Obviously, there are global investors who are focused on investing in China through our indices and our risk models. But we think that the opportunity is enormous, and we are very focused on building a strategy and expanding our footprint there, especially this year, in order to continue to capitalize on that significant opportunity and, obviously, continue to stay away from the geopolitics. And we'll have to comply with executive orders or legislation or whatever that comes our way, and that creates a lot of work for us. But overall, the big picture is nobody can really, at this point, negate the huge importance that China has and will have in portfolios around the world.

To provide more detail about our products, our largest traction in China is with analytics, where we have seen significant growth. As we develop our fixed income front office capabilities, along with a variety of security coverage and analytical capabilities focused on private assets, we are optimistic about the ongoing potential in analytics. Additionally, we are very excited about the opportunities in other products like ESG, where we are beginning to gain real traction, as well as in the index sector for the reasons previously mentioned. We see many avenues for growth in China.

I believe that last quarter, MSCI introduced 22 proprietary fixed income indices, bringing the total to 40. Baer mentioned this quarter that the run rate was approximately 10% in 2020. It appears that the momentum in this area has been quite strong. Could you discuss the pipeline for fixed income products? Are you still looking to invest in new products, or do you feel you have most of what you want and are now focusing more on sales and distribution to ensure investors see the growth potential soon?

I can tell you that our monetization of fixed income indices consists of our own indices and partnerships with others. A significant portion of our success has come from ESG and climate change fixed income indices created in collaboration with Bloomberg and Barclays, resulting in substantial asset inflows into those ETFs. We are also establishing additional partnerships with other fixed income indices to enhance our ESG and climate-related content. Furthermore, we have started developing our proprietary fixed income indices in areas that we see as having high potential. As for product variety, we aim to create a diverse range of MSCI-branded fixed income indices. We intend to steer clear of issuance-weighted and market cap-weighted indices and instead concentrate on areas where we provide unique and valuable content, such as ESG factors, climate considerations, and thematic investment themes.

I would highlight, we do have a very healthy pipeline of new opportunities, Owen. So I think you'll continue to see, hopefully, new ETFs and other passive products launched on our indexes. And we've got a healthy pipeline also of subscription-type deals on the fixed income index side. So it's very early days this year. As you know, we just launched our indexes about a year ago, but we continue to see pretty healthy demand.

Got it. That's very helpful. And then my next question is, I understand that most of the demand for your ESG products comes from like investors, like asset managers and asset owners. I think, Henry, you mentioned that your traction on corporates, it's quite strong. I think you have 80 clients right now, if I remember correctly. Do you think the recent Nasdaq Board Diversity and Disclosure Proposal can further accelerate the demand for your ESG products from corporates in the United States? Can you talk about your recent conversation with them in terms of subscribing into more MSCI ESG offerings, maybe both within the U.S. and outside the U.S.?

Yes, I believe there are two points to address if I understood your question correctly. Firstly, we have a wide array of fixed income products, including indices, risk models, and analytics, primarily aimed at asset managers and some asset owners. Our goal is to broaden this offering to insurance companies, which are significant investors in fixed income globally. This marks our entry into a client segment that has been challenging for us due to our limited fixed income product range. We are optimistic about expanding into life and property and casualty insurance for their own portfolios, focusing on fixed income indices and analytics. This will also include added value in areas like ESG, climate, and various themes, as that is where we can stand out, especially regarding climate change. Regarding corporate clients, with the growing emphasis on climate change and ESG, many have approached us for assistance. They seek guidance on necessary disclosures for ratings, understanding their competitive position within the industry, the types of data they should be generating, and how to communicate that data effectively to investors. To address this, we are focused on selling industry ratings and data to corporations, and we've established a corporate sales team to facilitate this. Additionally, we are collaborating with partners to develop a technology platform that will allow easy data transmission between investors and capital providers. We see considerable opportunities for growth in the corporate and issuer segments, particularly in their needs for ESG insights, climate change comprehension, and the ratings they require.

Henry, we've recently seen a couple of big direct indexing or custom indexing-related acquisitions across the space. I know there are some puts and takes for MSCI as that phenomenon grows. But just curious the degree to which you're having conversations with brokers, asset managers and technology providers to license your indexes. And just how you're thinking about that phenomenon more broadly? Do you think the hype is justified?

Yes, it's Baer here. I might take this one. We believe this is a category with significant opportunities for us, especially in light of the BlackRock acquisition and our strong relationship with them. Recently, we had a very attractive sale in the wealth segment driven entirely by direct indexing, along with a few others in different segments. We think the essential components, which include indexes, high-quality portfolio analytics tools, and various methodologies related to tax, are well aligned with our capabilities. This is our current perspective. I am confident that throughout 2021, we will provide you with new examples of our activities in this area, which will offer more insight into the opportunity, but we truly see it as aligned with many of MSCI's core strengths. Right now, we see it purely as an opportunity.

Sure. I would like to hear more about the wealth channel opportunity in ESG, especially since there seems to be skepticism among financial advisers regarding ESG. It seems the focus may be on selling your ESG solutions to institutions like home offices or custodians. Could you provide more details about your market approach and the solutions you plan to offer?

We have found that ESG and climate considerations have significantly enhanced our discussions with wealth organizations. There might be some differences between the home office and advisers, particularly in the United States, but this is not the case in wealth organizations across EMEA or even in emerging markets in Asia, where advisers see this as an opportunity. Feedback from intermediaries and advisers shows that their perspectives have shifted positively over the past year. We are excited about the potential this presents, as it opens up dialogues not only about ESG and climate, but also for some of our other product offerings. Overall, this represents a highly attractive opportunity for us in the wealth sector, serving as a gateway to many new possibilities.

Henry, maybe if you could just touch on a little bit further your growth aspirations in the futures and options area and how that may differ in the U.S. versus overseas.

We see a vast opportunity ahead. A few years ago, I projected revenue from futures and options at $5 million, expecting it to reach $50 million quickly and then $100 million or even $200 million in the next five to seven years. I was optimistic, and now we are actually on a path to achieve even higher revenues than I anticipated in that timeframe. The opportunity is significant. Traditionally, the listed futures and options industry has been a national market focused on single currency and single country exposures, with few exceptions like the EURO STOXX 50, which remains single currency despite being multi-country. MSCI operates in the multi-country, multi-currency space, and our exchange partners have figured out how to facilitate trading across time zones. We began in the U.S., expanded our efforts to Europe, and are now concentrating on Asia with the Hong Kong exchanges. Looking at a five- to ten-year horizon, I see the potential for revenue multiples beyond what we have today, with most of it translating to pure profit since it leverages existing indices. We expect this to evolve from market cap indices to encompass ESG indices, climate change indices, and thematic indices. At some point, we will also explore fixed income index exposure. There is substantial opportunity for us ahead.

And Craig, this is Andy. Craig, one thing just to highlight, just to keep in mind for the near-term expectations. The run rate over the last six quarters or so has really benefited from the repricing of agreements with many of our exchange partners. I would say those are largely complete, and we would expect the run rate growth to be more closely correlated with contract volumes going forward.

I appreciate that. But the other question I want to ask you, Henry or someone. Active versus passive, what percent of the U.S. equity market, Henry, do you think is passive now in the data you study? What is that number also in Europe? And maybe also just touch upon Japan, which I understand is much higher.

Yes. Look, there's always a lot of debate and discussion about this. And part of the debate is at what point is it going to reach saturation? And at what point is it going to tilt the balance? And at what point passive will create havoc? And all of that. We don't believe in any of that, and therefore, we have not spent that much time focusing on measuring how much is active, how much is passive and all of that. What I can tell you is that as it relates to our indices, there is about $3.5 trillion worth of money passively tracking our MSCI Indices. About $2.5 trillion of that is what we call institutional passive, meaning non-exchange traded, which is mostly institutional, some retail; and the other $1 trillion plus is obviously the ETF that we report. And that number keeps growing by leaps and bounds, and therefore, we believe that we're continuing to play on that theme.

Yes, I would like to add a comment. The category has significantly evolved compared to 10 or even 20 years ago. Many of the indexes we are developing are rules-based active portfolios. They are making an active bet on the market, but founded on specific rules. This distinction is important because the situation is much less straightforward. I believe there is considerable potential in the market for rules-based indexes with strategies, in addition to the market cap representations of them.

Craig, I'll share some approximate figures since you've inquired about them before, and we will keep refining these numbers. Though they are somewhat outdated, active equity assets under management are around $22 trillion, while equity indexed assets are roughly $14 trillion, with these figures being global. For fixed income, active assets are approximately $28 trillion, and passive fixed income assets are about $4 trillion. It's also important to highlight that there are significant opportunities across various asset classes, including fixed income.

I was wondering if you could go back to the point about the opportunity for ESG with corporate customers. And I was wondering if you could perhaps expand on the competitive landscape you see in that environment and how you think it might develop? And ultimately, what kind of size you think that opportunity might be perhaps in the context of the size of the market you see on the more investor side of ESG?

The opportunity initially arose out of necessity, as corporate clients sought to understand their MSCI ratings and how they compared to others in their industry or different sectors. They consistently inquired about this, prompting us to consider selling them the sector rating profiles instead of providing the information for free. This market is substantial, as we currently have around 20,000 issuers, with approximately 8,000 to 10,000 being companies and another 10,000 to 12,000 being fixed income issuers, and it's expanding. We also plan to venture into ratings for private equity and private credit. This represents a significant opportunity centered on data sales. We're already in the early stages of this initiative, and the next phase will involve determining how we can assist these clients in aggregating and presenting their data to investors. We're considering how to connect them with investors directly, and whether MSCI can play a role in that is still being explored, but it could uncover another opportunity.

Okay. That's helpful. Lastly, could you discuss the retention rates in the Analytics business? I know you've mentioned some challenges in the industry, which has made this year difficult. Could you provide insight on that trend through 2021? Additionally, is there anything specific we should note regarding the dip we observed this quarter?

Yes. Sure. So a couple of things to highlight, and I mentioned this earlier, we obviously saw a dip in the retention rate this past year. It was primarily driven by two segments: hedge funds and within hedge funds, with smaller hedge funds and then within banks. And it was particularly one large cancel in the quarter from a bank. We continue to see, we believe, relatively healthy sales within Analytics, and the pipeline right now looks reasonably healthy for 2021. And so we're optimistic. We think on the cancel side, a lot of these are not in the most core parts of the franchise. And so we are hopeful that those will continue to moderate and trickle through to growth going into 2021.

I would just like to clarify that the large bank cancellation occurred this quarter.

Correct. Yes, Q4.

I wanted to inquire about the investments you're making. You've provided a good amount of insight into the discipline you're applying as well as the product, market, and client segments involved. At a high level, I'm curious if you have a total addressable market or another perspective on the total opportunities available, or if it's more of an entrepreneurial approach where you continually seek out new business. Any details on that would be appreciated, along with your thoughts on the regulatory environment concerning ESG and whether it serves as a significant enabler.

That's a good point, but it's part of the latter rather than the former. We are in a position where we are largely creating the industry, specifically focusing on developing indices for every portfolio and investment tools for critical investment decisions. The demand is significant. Numerous clients approach us asking for custom indices, improved software, assistance with ESG, and risk management. There is substantial interaction with clients on these requests. Currently, it seems that our addressable market is quite large. We haven't dedicated resources to measure its exact size because we're focused on quickly taking advantage of the opportunities available to us, which we expect to continue for several years. Therefore, we don't see the need for a centrally planned approach to model the total addressable market.

And Henry on the regulatory front, clearly, it's headed in the right direction. I think with the change of administration in the U.S., it seems like it's going to be more conducive in terms of encouraging more ESG disclosure and better ESG practices, which naturally benefits us. I think you see some tangible examples of regulation in Europe that are starting to impact us, including TCFD and the impending SFTR regulations which require disclosures, which we are very well suited to do, and we're well positioned to help financial institutions make the required ESG-related disclosures, and we expect those types of trends to continue.

Got it. All right. As a final follow-up, looking at how passive investment represents such a significant portion of the U.S. equity markets, I understand it's not exactly within your responsibilities since you provide the indices and data. However, do you ever consider whether there might be risks associated with passive investing that could affect the equity market structure and limit its growth?

I think we are still quite distant from that concern. The area that is always a point of concern is that a significant part of passive investing involves momentum investing. Essentially, the larger a company's weight in an index, the more it gets purchased. However, this can be said about many types of investment strategies and isn't unique to passive investing. We need to closely examine the underlying purchases that investors make. Passive investing has initiated a significant change by shifting focus from stock picking to asset allocation, covering various sectors, geographies, and the balance between fixed income and equity. This approach has saved an incredible amount of time and delivered substantial value to society because it allows for easier movement through packaged securities, such as ETFs.

I know we're running long here, so I'll be brief. Andy, I wanted to follow up on a comment you made regarding some delayed deals you mentioned. Can you provide a little more detail on that? Was this a result of pulling forward business, or do you think this is business that you were able to close more of due to the opportunities you're presenting this quarter?

Yes. It was a little bit of both. I think it was a tool that was, I think, instrumental in helping some clients right on the heels of the pandemic when it unfolded and was well received by certain clients. It's also a tool that has been helpful with, I'll call them, large strategic deals for clients who might be signing up for a significant purchase of one of our offerings and using it across their organization. And maybe just to provide a little bit of color on how these things are structured. And firstly, before I do that, I just want to underscore. I don't want to overstate the impact of these. This is just one component of what drives the disconnect between run rate and revenue, but it is something that we used more this year. We will likely use them going forward, although I think that the pace should not increase materially. But the way, these work, and maybe I can give you just a quick example to make it very tangible. So if a client signs up to an agreement to access one of our products, at the beginning of the contract term, we provide the client with access to the product for, say, three months at no cost. And let's say, the client pays us $180,000 for the next 12 months. So in that case, we would recognize the $180,000 as a sale and the run rate goes up when the client signs the contract. So that's at the beginning of the free trial period, if you will, or that period where they're not paying. Although we will recognize the revenue of the $180,000 over the 15-month time period. So we'll effectively be recognizing that $180,000 over 12 months, which works out to about $144,000 of revenue for the 12 months after the contract is signed. When that client renews, so when they renew, it's for an annual term, again, this is all just illustrative. But when that client renews, it's for an annual term. Assuming no price increase, they would stay flat at the $180,000. And so the run rate and revenue sync up on the renewal for the second term.

Got you. And then is it possible to perhaps quantify, I think that was like 1% to 2% of your growth in your run rate business? Is that too much?

Yes. I can't provide exact details, but I can say it was utilized within Analytics, which we have previously mentioned. We have also applied it selectively in ESG, but I want to highlight that the impact within analytics is typically not greater than the effect of implementations. We do not start recognizing revenue until the implementation is complete, even though we record the sale once the client signs the contract. This tends to have a more significant impact than other factors. However, we wanted to note that there was a slight increase in 2020, and it may affect future outcomes.

Well, thank you very much, everyone, for attending today. We look forward to speaking with you again during our Investor Day event on February 24. In the meantime, please stay well and stay safe.