Interview: Baer Pettit, President of MSCI

MSCI’s objective, says CEO Baer Pettit, is “to be a multi-asset-class provider of financial tools to help clients build better portfolios and better understand the risk-return characteristics within them”. That is a big jump from MSCI’s origins as a pure equity index provider when it started life in 1969 as a joint venture between investment bank Morgan Stanley and fund manager Capital Group International.

The index business still dominates MSCI, accounting for about $800m (€689m) in revenues out of a group total of $1.4bn in the 12 months to the end of April 2018. But other areas are growing fast and suggest that the domination of the index business might be coming to an end. The analytics business already accounts for $500m of the total, with the remaining $100m or so accounted for by ESG-related services and indices at $90m and the balance from MSCI’s real estate-related activities. The two outliers in terms of growth though, says Pettit, are equity factor-related activities and ESG. 

Moving away from the shackles of being a pure index provider has created its own challenges. The manner in which the firm went about that has been chiefly through a series of acquisitions that started in 2004 with the acquisition of Barra, adding equity risk and portfolio construction components onto the core equity index business. That, says Pettit, led to the realisation that there was a significant future in multi-asset-class portfolio construction. This led to the purchase of RiskMetrics. 

A by-product of this acquisition was that RiskMetrics owned a couple of companies that became the core of MSCI’s ESG service offering – a small business then, but now enjoying dramatic growth. Another key acquisition was the purchase of real estate performance measurement group IPD in 2012. 

For a technology-based company that purports to offer its clients seamless access to all its capabilities, growth by acquisition raises existential questions. “We had many disparate systems, disparate databases and disparate technologies which led to practical blockages to us achieving our strategic goal,” says Pettit. The big theme over the past three or so years has been the integration of systems and data. “We used to have three separate equity databases – the index business, Barra and RiskMetrics. We have integrated those over the last few years and we are now in the process of doing that for fixed income,” he says. 

It is not just data and systems that need to be integrated though. The management and monitoring of risk first of all requires a definition of what constitutes risk for the user and that can differ dramatically depending on the time horizon. RiskMetrics uses measures of risk, such as value at risk (VAR), which estimate probabilities of future losses based on historical market movements. But VAR figures are typically used over short time horizons; with banks this could be a matter of days. The typical time horizon for Barra equity risk factors is a year, while- pension funds have time horizons that run over decades. 

RiskMetrics also measures risk at an individual security level, while Barra is looking at common factors across securities which may be economic, sector and country-specific. As Pettit says, integrating the disparate acquired businesses also requires a theoretical and philosophical amalgamation.

In practice, integration has required fewer philosophical debates and more mathematical. The issues arise around time horizons and aggregation. A day trader and pension fund with a 20-year horizon may wish to use different tools. “That doesn’t mean that one is right or wrong, just that one is better fitted to one purpose than another. Our analytics offer something for both,” says Pettit.  

“Twenty years ago there was something like a religious war between quants and fundamentalists as investors. That is, to a large degree, a thing of the past. There has been a whole new generation coming into the industry who take the principles of quantitative finance for granted.” For MSCI it has meant that asset managers increasingly want to integrate traditional quant techniques with those used by stockpickers. That means using tools that suit their investment process rather than ones imposed on them. 

While MSCI operates in several different areas, Pettit argues that the boundaries between them are becoming blurred. This certainly creates new opportunities but also means the firm faces new competitors. At the index level, its traditional peer group is well known in capitalisation-weighted equity indices – FTSE Russell, S&P. But in the high-growth areas of factor indices and factor exposures there are many other firms. 

“BlackRock is a huge client of ours but also a major player in analytical tools. Bloomberg is now the owner of the erstwhile Lehman and Barclays fixed-income indices. It is always developing its market tools.” Pettit argues that asset managers will increasingly have to have better analytical capabilities whether they build them themselves or whether they use external tools to provide transparency in what they offer. Different players will increasingly have similar tools in their armouries.  

As a business with enormous amounts of complexity in terms of data and systems running 24 hours a day around the world, operational risks are always at the forefront. Pettit is well aware of that and has begun an additional drive within the organisation around innovation: “We are justifiably paranoid, so we are looking at new technologies; seeing how artificial intelligence can build factors better. We have a lot of tentacles to start-ups of all kinds.” 

As a firm that is pushing efficiency and transparency in the financial markets generally, MSCI has to be constantly aware of who could be more transparent and efficient than itself, says Pettit. The threat lies in the combination of new technologies with disruptive business models. “How can we continue to be a disruptor and use technology to be at the cutting edge of continuing to create efficiency and transparency in the years ahead?” asks Pettit. The answer to that may well lead to the firm changing its appearance completely.