MSCI president defends decision to include China
Baer Pettit is introduced as “front and centre” of MSCI’s work with clients by an enthusiastic press officer for the indices and data analytics provider.
“I am?” asks Mr Pettit with mock surprise.
He has in fact helped position MSCI at the heart of some of the most powerful trends shaping global finance as he rose through a number of senior roles over two decades to become company president.
The huge power of index providers and their role helping to direct investor inflows globally is attracting mounting scrutiny from regulators and politicians.
Marco Rubio, a Republican senator, accused MSCI last year of funnelling US investor cash to China’s communist party by lifting the weight of Chinese companies with links to government’s military and intelligence services in its flagship emerging markets index.
“MSCI’s decision to include Chinese companies in its indices raises serious questions and concerns about the quality of depth of the diligence undertaken throughout its decision making process,” said Mr Rubio.
MSCI executives were outraged, pointing out that the decision to include Chinese equities followed detailed consultations with clients and lengthy negotiations with Beijing that resulted in market reforms.
Mr Pettit phrases his responses diplomatically.
“We will see more critics arguing that index providers have too much influence but we stand by the integrity of our processes. There really isn’t anything sinister going on. The inclusion of countries within MSCI indices is technically driven and our processes are transparent to regulators and our clients,” he says.
Throughout the interview in MSCI’s office in London, he appears entirely relaxed, leaning back in his chair while answering questions.
Benchmarked assets $12.3tn
Headquarters New York
Listings New York Stock Exchange
European regulators introduced new rules governing financial benchmarks in 2018 to prevent a repeat of the Libor scandal. Index providers had effectively been unregulated before this but Mr Pettit says the new rules have had minimal impact.
“Index companies are coming under greater regulatory scrutiny for sure. We are fine with it. The rule changes involve more logging of our actions, the editorial processes and decisions. But it would be a concern if regulators started to impose divergent rules in different markets as we effectively run a global process,” he says.
Arguably the biggest challenge facing investors across the world is assessing the potential risks of climate change for their portfolios, a process fraught with uncertainties.
MSCI is aiming to help clients to better integrate environmental considerations into their investment processes with a new climate value-at-risk model, which has just been launched following the acquisition last year of Carbon Delta, a specialised data and analytics provider.
“The climate VAR model can provide clients with a means to identify assets that are at risk from extreme weather hazard such as flooding. Nearly 7 per cent of the facilities owned by the 3,046 companies in the MSCI All Country World index are threatened by coastal flooding. Half of these facilities might become untenable by 2050,” he says.
MSCI expects to see large-scale reallocation of capital over the next few decades because of the shift to a low-carbon economy and a significant repricing of financial assets as investors integrate environmental, social and governance considerations more fully into their asset allocation decisions.
“More and more data is showing that incorporating high ESG standards can reduce risks. It will become harder to argue going forward that ESG is not part of an asset owner’s fiduciary duty,” says the 55-year-old and father of three.
In November, MSCI made ESG ratings on more than 2,800 companies publicly available. The ratings are constructed using 1,000 data points from company reports and alternative data sources. MSCI plans to expand the ESG ratings to 7,500 companies before the end of this year.
“We want to encourage an open discussion among investors and companies on how to improve sustainability across the board,” he says.
He adds that “real regulation” will be needed from governments to curtail damaging carbon emissions. “ESG can be a positive accelerant but it will not be sufficient on its own to reduce carbon emissions.”
Born 1964 London
Total pay $2.9m in 2018
1982-85 Master of arts in history, university of Cambridge,
1985-87 Master of science in foreign service, Georgetown University
1992-00 Bloomberg, sales manager
2000-01 MSCI, head of European client coverage
2001-12 MSCI, global head of index
2015-17 MSCI, chief operating officer
2015 to present MSCI, global head of products
2017 to present MSCI, president
MSCI in January agreed to pay $190m to acquire a minority stake in Burgiss Group, a provider of performance data covering close to 10,000 private investment vehicles that hold assets of $7tn.
Mr Pettit says that MSCI aims to bring more transparency to the reporting of private assets. MSCI will also gradually integrate its ESG analytics with Burgiss private markets data.
“Private equity firms are showing an interest in ESG for sure. The main problem is data availability and some frictions may arise around transparency requirements. A lot of work needs to be done but it is moving in the right direction.”
About $12.3tn in assets is benchmarked against MSCI’s public market indices, the core of its highly profitable business. MSCI’s indexing unit generated a 72.8 per cent profit margin in 2019. Fee rates for ETF managers have been declining slowly but price declines have been more than offset by huge increases in assets in tracker funds.
Assets in ETFs linked to MSCI indices reached $934bn at the end of 2019, up 34 per cent on the previous year-end. The combination of massive investor inflows into index tracking funds and multiple stock markets reaching new peaks has helped to turbo-charge MSCI’s earnings growth. It reported net profits of $564m in 2019, up 11 per cent.
MSCI shares, which have returned 2,325 per cent (including dividends) since the US stock market reached its post-crisis low in 2009, trade on an eye-wateringly high valuation, about 40 times estimated earnings for 2020.
Manav Patnaik, an analyst at Barclays, who has an “overweight” recommendation, says investors frequently question the high valuation. But he believes the premium is justified because prospects for MSCI revenue streams related to its derivatives, private markets and analytics operations are under appreciated.
“MSCI addresses the themes that are growing in importance to investors including the shift from active into passive strategies, the globalisation of financial markets, ESG investing, multi-asset risk analysis and the rise of illiquid private assets,” says Mr Patnaik.
Mr Pettit’s recipe for MSCI’s future is straightforward.
“We survive and prosper if what we do is transparent, high quality and reliable. Investors have a choice whether to use MSCI or not,” he says.