明晟 (MSCI) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the MSCI Third Quarter 2018 Earnings Conference Call.

(Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the call over to Mr. Andy Wiechmann, Head of Investor Relations, Strategy and Corporate Development.

You may begin.

Thank you, Hermione.

Good day, and welcome to the MSCI Third Quarter 2018 Earnings Conference Call.

Earlier this morning, we issued a press release announcing our results for the third quarter 2018.

A copy of the release and the slide presentation that we've prepared for this call may be viewed at msci.com under the Investor Relations tab.

Let me remind you that this call may contain forward-looking statements.

You're 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 in our most recent Form 10-K and our other SEC filings.

During today's call, in addition to GAAP results, we also refer to non-GAAP measures, including, but not limited to, 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 a baseline for the evaluation of results.

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 on Pages 22 to 26 of the earnings presentation.

We will also 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 Kathleen Winters, our Chief Financial Officer.

With that, let me turn the call over to Henry Fernandez.

Thanks, Andy, and good day, everyone.

The exceptional results from the third quarter, including the 11% growth in organic subscription run rate, reflect the power of the MSCI franchise and highlight the growing importance of that franchise in an investment industry undergoing a significant transformation.

We continue to benefit from favorable secular trends, particularly with the continued growth in global investing, utilizing passive strategies, adopting ESG and track the factor criterion and using risk management frameworks.

On top of these secular trends, we have a very diversified business at MSCI, basically, an all-weather franchise with natural hedges in a wide range of market regimes.

We benefit one way or another in any market whether it is: active or passive; risk on or risk off; high volatility or low volatility; developed or emerging markets; U.S., Europe or Asia; sustainable investing or not; asset owners, asset managers or trading firms; strong dollar or weak dollar; high valuations when we sell businesses like we've done in last few months or low when we buy them, hopefully, someday in the future; high MSCI price when we feel good or low MSCI price when we buy lots of shares.

We basically have a franchise that capitalizes in most market environments.

Let me now give you a few example from the clients' perspectives.

In these volatile conditions, our clients are increasingly using our risk management tools to better understand their exposures, run scenario analysis and position their portfolios for various market shocks.

To gain insight into the drivers of performance and risk and to build portfolios in this volatile market environment, our clients are showing elevated interest in our factor analytics and factor indices.

For investors that expect sustained economic growth with moderate inflation and gradually rising interest rates, our factor analytics and factor indices help them build portfolios around strategies that outperform well in these scenarios, such as growth, momentum and procyclical sectors.

Alternatively, investors that believe that trade wars, increasing inflation and rising interest rates will hinder economic growth use our factor tools and factor indices to help them take advantage of strategies, like minimum volatility, quality, value, high dividend yield or defensive sectors.

Given the weakness in emerging markets, our clients are showing a strong interest in all our emerging market content, from indices to risk models to ESG.

Our emerging market and single-country risk factor models, including our recently released China equity model 6, help clients better understand the drivers of performance and risk in those markets.

Recently, we are seeing a growing level of attention on companies that lack transparency, engaged in socially unacceptable behavior, damage the environment or are governed in ways not aligned with shareholder or constituent interests.

These trends continues to drive and fuel the growth of all our ESG products and services.

In summary, MSCI's trend is that we have tools to help the investment community in any market environment.

We look forward to keeping you posted on our progress and our future successes.

We are hosting an Investor Day on February 28 of next year to provide a deeper dive into the ongoing industry transformation and how MSCI is well positioned and has attractive growth opportunities in that transformation.

Let me now turn the call over to Baer Pettit.

Thank you, Henry.

Our ability to help clients is reflected in both the strong product growth, shown on Slide 5, as well as by the double-digit subscription run rate growth we're seeing across asset managers, asset owners, investment consultants, wealth managers and broker-dealers, which collectively represent more than 87% of our subscription run rate.

As Henry mentioned, this success is amplified in the current market environment.

The results are being driven by our continued investment and strong execution in 3 key areas: one, expanding our research and content in order to remain at the forefront of providing insights into the latest investment trends; two, enhancing our go-to-market strategy and driving an integrated client solutions approach, including building out and enhancing the effectiveness of our global sales and client service organization; and three, delivering flexible, cutting-edge technology, including our new platform.

This consistent execution is allowing us to further differentiate ourselves relative to the competition.

This has been particularly noticeable within Analytics.

By delivering new content, improved platform functionality and continual enhancements to our client engagement model, we have further differentiated our best-in-class offerings and our ability to deliver actionable solutions for our clients.

These efforts have driven improvements in Analytics growth as well as better positioned us to help clients in volatile environments.

Among other enhancements, in the third quarter, we introduced a new mortgage prepayment and rate model as well as expansions of our fixed income, asset pricing and benchmark curves; a new multi-asset class factor model suite with capabilities for strategic asset allocation, in addition to a new China equity model, adding increased insights into emerging markets; full integration of our ES&G content into all analytics applications, allowing our clients to easily integrate ES&G ratings, data and indexes into their security selection, portfolio construction, stress testing and risk analysis.

Additionally, a broad range of enhanced functionality across our Analytics platforms enables us to help our clients more effectively and efficiently achieve their investment objectives.

These ongoing enhancements are improving our client value proposition and helping us secure new opportunities across a broader range of use cases.

Here are a few examples from Analytics in the third quarter.

Through our best-in-class content and strong client relationship, we won a large upsell with an existing U.S. asset manager to use our models and applications in order to run factor exposure analysis and stress testing for their global equities team.

As a large and long-standing client of the firm, the client's internal risk system is already powered by our risk analytics API, and the client leverages our equity portfolio analytics.

The additional license will enable them to stress test their equity portfolios in a way that is more helpful to the portfolio managers with factor shocks and historical stress analysis.

In another example, we won a large new deal with the derivatives structuring desk of a major European bank to use our risk analytics API to provide scenario analysis and risk analytics to holders of swaps issued by the firm, allowing them to offer differentiated insights to their derivatives clients.

We won the deal through the breadth and uniqueness of our analytics capabilities and our ability to combine those in a way that helps the clients achieve their specific business objectives.

Similarly, we won a significant contract with a very large Asian securities firm to license our WealthBench offering to help them transform their wealth business from a brokerage model to an advisory one by allowing 5,000 advisers across 155 branches to deliver tailored investment planning proposals to their clients.

We won the deal because of our high-touch service model, institutional quality analytics and our ability to analyze a wide range of securities and a very large number of portfolios.

Beyond Analytics, we continue to roll out new content and capabilities across the firm that position us to better help our clients.

Here are a few further highlights from this quarter that illustrate our progress across product lines.

We launched several new ES&G Indexes, such as the MSCI ex Tobacco Involvement Indexes, which are designed for asset owners to standardize their divestments from companies involved in the tobacco business.

And we launched our MSCI Real Estate Enterprise Analytics offering, an interactive application that provides real estate investors and managers with the ability to evaluate and analyze the drivers of their portfolio performance as well as review exposures and concentrations across market appetites and segments.

We remain excited about the wide range of opportunities in front of us, and I look forward to keeping you posted on our progress in creating more client and shareholder value.

With that, I turn the call over to Kathleen.

Thanks, Baer, and hello to everyone on the call.

I'll start on Slide 6. Q3 was another quarter of great execution.

Our disciplined approach to investments continues to yield strong results as we delivered exceptional revenue and EPS growth as well as strong cash flows.

Revenue growth in the quarter was driven by strong momentum in our recurring subscription revenue, growing 10%, with continued strength in Index and ESG, up 12% and 34%, respectively.

ABF revenue, which comprises 23% of our total revenue, grew 13% and was driven by higher AUM of equity ETFs linked to our Indexes and our non-ETF passive business.

Average AUM in MSCI linked-equity ETFs was up 16% from the same period last year, largely driven by strong cash inflows over the last 12 months.

ABF revenue from non-ETF passive funds linked to MSCI Indexes was up 21%, mainly driven by an increase of 15% in average AUMs.

Moving to Slide 7. You can see the key drivers of our adjusted earnings growth.

Our subscription business was the largest driver.

In addition to strong new sales, we continue to maintain a very high retention rate, 95% this quarter.

EPS also benefited from a reduced corporate tax rate due to U.S. tax reform and, to a smaller extent, our tax restructuring work, which better aligns our tax profile with our global operating footprint.

Now let's turn to our segment results on Slide 9. Within the Index segment, we have strong subscription revenue growth driven by our core market cap weighted products as well as our custom and specialized Index products.

We see our investments around new data sets and faster production paying off.

For example, in recent quarters, we have developed and licensed numerous custom ESG and factor indexes for several large asset owners, which are being used for a wide range of uses, including as benchmarks for active mandates and for passive replications.

Our Analytics segment grew 6%, excluding the impact of foreign currency and the divestiture of our FEA business, largely driven by our focus on expanding use cases.

Multi-asset class solutions contributed about 2/3 of the growth, driven mainly by demand for our risk and liquidity Analytics tool sets.

On July 30, we announced the divestiture of InvestorForce, which was subsequently completed on October 12.

As a reminder, the run rate impacted about $17 million.

In our All Other segment, the growth was mainly driven by ESG with run rates up 28% versus the prior year.

We continue to see strong growth in EMEA and Asia Pac with run rate growth of 32% and 61%, respectively, as investors increasingly integrate ESG into their investment processes.

Slide 10 provides a summary of our key operating metrics by segment.

Organic subscription run rate growth continues to accelerate, up 11%, with growth across all client segments.

Asset owners and asset managers were up 13% and 11%, respectively.

In Index, we had strong growth in both asset-based fees and subscription run rates, up 13% and 11%, respectively.

Asset-based fees have benefited from licenses of our indexes for new equity ETFs and new asset owner mandates for passive funds.

However, recent market volatility and, particularly, the market depreciation of emerging market equities was a drag on ABF growth rates in the quarter.

Within the Index subscription run rate, newer modules continue to drive robust growth.

Loan rates for factor and ESG modules grew by 42% and 48%, respectively.

Custom and specialized modules have also performed very well, growing at 24% and 14%, respectively, as clients are turning to MSCI to help them provide differentiated product offerings.

Our largest client segment, asset managers, grew 9% in Index subscription run rates as we continue to broaden and enhance our content.

We've also had great success selling our Index content to asset owners and wealth managers with subscription run rate growth in these client segments of 24% and 28%, respectively.

Our ability to expand content has allowed us to capture new business across all client segments as indexes are increasingly being used by clients to develop and reflect their investment strategies.

Year-to-date, Index recurring sales are up 19%, and the Q3 Index retention rate remains very strong at 96.1%.

Within Analytics, our accelerating growth has been attributable to broader content and capabilities, new use cases and our One MSCI go-to-market approach.

The Analytics retention rate was 94.1% compared to 93.4% prior year Q3.

The recurring net new growth for Analytics was up 27% versus the prior year, benefiting from a large WealthBench win in Asia, as Baer described earlier.

On Slide 11, we provide an update on 2 key areas of integrated content, factors and ES&G.

We continue to see strong client demand in both areas.

In factors, AUM in equity ETFs linked to MSCI Factor Indexes grew to $84 billion, up 48% year-over-year, driven in part by increasing usage by wealth management firms.

In ESG, we passed a substantial milestone.

Our ESG ratings and research run rate, combined with ESG Index run rate in our Index segment, surpassed the $100 million mark, more than doubling in just 3 years.

We see strong ESG demand across all client segments with 27% subscription run rate growth in our largest segments, asset managers and asset owners, who are integrating ESG into their investment processes.

We're also seeing wealth platforms and retail brokers building ESG-focused model portfolios.

New clients contributed about 60% of recurring sales in the quarter for ESG.

We're accelerating our investment in ESG as we continue to broaden our ratings coverage and incorporate broader data sets, including a wider range of alternative data points.

Turning to Slide 12.

We highlight the drivers of our asset-based fees in more detail.

In non-ETF passives, our strong institutional investor relationships are driving a growing number of mandates tied to indexes.

And in futures and options, we're excited about the increasing volume, which is driving more liquidity.

Year-to-date, futures and options volume was up roughly 23% versus the prior year, and run rate was up 21%.

We believe revenue from these products have a long trajectory of growth ahead.

Overall, growth in ABF revenue has been moderating the last couple of quarters.

On a year-to-date basis through September 30, we've seen market depreciation reduce AUM in these equity ETFs by $16 billion, driven by the emerging and developed markets outside the U.S., while cash flows increased AUM by $37 billion.

We remain confident in the long-term growth prospects in equity ETFs, including factor and ESG ETFs.

Year-to-date, we've licensed our indexes for 83 new equity ETFs, 51 of which are based on our factor and ESG Indexes.

Total AUM of these equity ETFs have grown by 11% sequentially, bringing the total to $108 billion as of September 30.

While favorable, long-term secular trends remain intact, we do expect ABF run rate growth to continue to moderate in the near term as AUM growth potentially remains constrained by market pressures.

In Q3, we saw effective basis fees decline by 0.06 basis points.

This was consistent with our expectations for continuing fee pressures and was primarily driven by a shift in product mix.

We continue to expect lower fee products to capture a disproportionate share of new flows into equity ETFs, and we expect a further decline in our average basis point fee levels as part of our efforts to capture volume and achieve continued run rate growth.

Our ETF partners are continually evaluating their market opportunities for existing and new products as well as the optimal positioning and pricing of those products.

As such, we have discussions with all of our key ETF partners about our fees and fee constructs on an ongoing basis.

Now let's turn to Slide 13, where we provide some additional detail on quarterly net cash flows.

Equity ETFs linked to MSCI Indexes are heavily diversified across strategies and geographies with about 22% exposure to the U.S. markets, and the remainder is spread across emerging markets and developed markets outside of the U.S.

Across the global ETF landscape, in Q3, there was about $100 billion in net inflows into equity ETFs, up sequentially from the $60 billion in Q2.

Investors continue to favor the U.S. with about 72% of the Q3 flows going into U.S. exposure ETFs.

Last quarter, about 80% of the flows went into U.S. equity ETFs.

Outside of the U.S., cash flows into non-U.

S. equity ETFs have been relatively muted with only about $28 billion in Q3.

The overwhelming majority of these flows were into domestic equity ETFs, where the ETF exposure and the listing country is the same, pointing to investors' concern about investing in the global markets.

Now turning specifically to MSCI-linked ETF flows.

We experienced similar dynamics to the market.

On a year-to-date basis, we've seen solid flows into equity ETFs linked to MSCI Indexes with U.S. exposure, capturing about 10% of total U.S. exposure equity flows, roughly in line with our share in this market.

Equity ETFs based on our indexes in key growth areas, such as factor and ESG, continue to gain momentum.

Equity ETFs based on our factor and ESG Indexes, on a combined basis, captured 43% of cash flows into factor and ESG ETFs on a year-to-date basis.

In Q4, we continue to see additional pressure on AUM levels, given broad market volatility.

Despite the recent market headwinds, we remain confident in the long-term secular move to index-based investing and our ETF provider licensing strategy to increase our market share through volume growth and drive long-term run rate growth.

Turning to the next section.

We provide an update on our capital, liquidity, 2018 guidance and our 2019 planning framework.

On Slide 15, we provide our key balance sheet indicators.

Our balance sheet remained strong, allowing flexibility and giving us the firepower to capitalize on the right opportunities at the right time.

Having this flexibility will allow us to generate strong returns for our shareholders as we evaluate the best uses for our cash.

Year-to-date, we've repurchased about 2.6 million shares at an average price of about $151 a share for a total value of $388 million.

Turning to Slide 16.

We have some updates to our guidance.

We're raising the bottom end of our operating and adjusted EBITDA expense target.

In Q4, we expect some additional costs related to compensation, investments in marketing for our widely used indexes and also severance as we continue to optimize the organizational structure.

Operating expenses are expected to be in the range of $743 million to $750 million, and adjusted EBITDA expenses are expected to be in the range of $658 million to $665 million, likely coming in at the high end of those ranges.

Before we get to our planning framework, I'd like to take a moment to highlight our substantial progress over the last 3 years and the alignment of our long-term compensation strategy with shareholder interests.

Reflecting on the company's evolution, our strong financial results have been directly attributable to our focus on client needs, innovation and the consistent execution of our strategy.

We delivered a nice acceleration in our growth rate, particularly in our recurring subscription business.

We've improved our subscription run rate growth from an organic growth rate of 8% in 2015 to 11% this year.

We believe that our all-weather franchise brings great value to our clients through different market cycles.

We're well positioned to serve a wide spectrum of investors and multiple client segments.

Furthermore, we've been highly focused on driving efficiency and productivity gains to free up resources to enhance our products and further improve profitability.

As a result, we've delivered a healthy rate of margin expansion.

Finally, we're very focused on ensuring that capital is optimally deployed to enhance shareholder return.

The market has recognized the company's success and has driven an increase of over $6 billion in shareholder value over the last 3 years.

We're highlighting this value creation because it is significant and because it is aligned with the multiyear PSU awards granted to our executives in 2016.

These awards were intended to align our executive compensation program with our 3-year strategic plan and shareholder interests.

The value is based on achievement of a challenging multiyear TSR CAGR performance metric.

This incentive has worked very well and will cliff vest in Q1 2019.

While the award is accrued over the vesting period, that is Q1 2016 through Q1 2019, there will be a related payroll tax upon vesting in Q1 2019.

This will be offset by an income tax windfall benefit, driven by this vesting.

The actual impact will be dependent on the share price over the measurement period and on the vesting date but is likely to be a net benefit.

The multiyear PSUs granted in 2016 cover 3 years of the annual PSU component of long-term incentive compensation for senior executives, and therefore, these executives did not receive any PSU grants in 2017 or 2018.

Given the uniqueness of the size of the grant, we will be excluding the payroll tax expense as well as the income tax windfall benefit from our adjusted figures in 2019.

The dilutive impact of these shares are already accounted for in our diluted share count.

Now let's turn to Slide 18 so I can take you through how we're approaching 2019.

We're currently working through our planning process and will give you our 2019 guidance when we report Q4 2018 results.

But in the meantime, we wanted to provide you with some color around what we're seeing in the market and what we're doing to capitalize on these trends.

We believe that market trends remain, overall, favorable.

Globally, professionally managed assets continue to grow.

Investors are focused on drivers of performance and risk and the value generated by managers.

Growth in index-based investing also continues to be key element and tailwind for our business, driving strong demand for our content and services.

Investments we've made in these areas are paying off, and our subscription business continues to benefit from these trends.

Our ABF revenues are also benefiting from these investments with strong growth in areas like factors and ESG, which continue to gain traction with investors and are increasingly becoming a key component of the investment decision process.

However, ABF revenue may, at times, face near-term challenges depending on flows and pricing.

We expect to continue to invest in high-return projects.

We've improved our systems, processes and culture, which has enabled us to quantitatively track and manage our investments and expense base to drive continued innovation, effective capital allocation and enhanced return on investment and shareholder returns.

Finally, we continue to approach share repurchases in line with past practice, by repurchasing more shares when there's softness in the market and when we have more excess cash and fewer shares when volatility is low and we have lower excess cash balances.

In summary, our recurring subscription business continues to grow at a very healthy pace.

We expect to continue to invest in areas around content, technology and services to drive top line growth.

Our results this quarter have demonstrated our consistent strategy and execution, which has resulted in robust shareholder returns.

We're confident in our long-term growth prospects, and we look forward to keeping you updated on our progress.

With that, we'll open the line to take your questions.

(Operator Instructions) Our first question comes from Alex Kramm with UBS.

I wanted to start on the Index subscription side of the business.

I think some of you, and I think, Henry, you as well, mentioned that there's been more interest in the U.S. than -- EM, in particular, struggled.

I think non-U.

S. developed as well.

So I noted -- I noticed the 3Q's nonrecurring subscription sales and Index being a little bit softer here, but really flat with last year.

So just wondering if -- those customers clearly are having a little bit of a harder time, some of your core customers.

Is it harder to get pricing?

Is there -- is the sales environment tougher?

And in particular, what's the look into the fourth quarter, given that, that environment continues to be pretty poor and the fourth quarter is supposed to be a big sales quarter for you generally?

Yes.

Alex, no real change whatsoever on our clients with respect to Index subscriptions and interest in all the various categories.

So our pipeline remain healthy.

There is no abnormal situation one way or another.

I think there are always timing considerations.

And Kathleen?

Yes.

No, Alex, thanks for the question.

To your point, recurring sales being flat year-over-year, a couple of things to kind of point out to kind of take that in context.

Number one, prior year Q3 was fairly strong, so some of it is just related to comps year-over-year.

But really, importantly, Q2, remember, was a really high sales quarter, in fact, highest recurring sales ever, up 53%.

So we had a really strong Q2.

When you look at it over a longer period of time rather than just discrete quarters, on a year-to-date basis, we feel really good about the performance of the Index product segment and, particularly, the subscription portion of that franchise.

Recurring sales year-to-date are up 19%.

All the regions look pretty good, particularly seeing great strength in EMEA and Asia Pac.

And in fact, our retention is very high at 96%.

So when you look at it in the context of the full year performance, we feel pretty good about it.

Okay.

So no worries about the environment or the expected 4Q big quarter usually in the fourth quarter, I guess, is what I'm hearing here.

Exactly.

I mean, nothing really.

As Henry said, pipeline looks pretty good right now.

All right.

Then just shifting gears real quick.

On the expense side, appreciate all the commentary.

But you're clearly acknowledging the challenges on the ABF side, and it sounds like maybe next year, there could be a little bit of a reaction, if I heard you correctly.

But I'm still a little bit surprised that you're getting rid of InvestorForce.

Clearly, it's a tough environment, and you've been seeing it coming.

And people have been asking about your expense flex, but now you're coming in at the higher end of the range, it seems like.

So maybe just flesh it out a little bit.

I think some people would've hoped for a little bit more reaction quicker to what's going on in the marketplace.

So on InvestorForce and FEA, the commodity analytics business that we sold earlier in the year, the -- it's an answer to we are dogmatically always looking at our focus, our strategy.

And anything that deviates from that strong focus and strategy and doesn't belong will be sold and especially in a very good, high market valuations.

So that's -- that one.

On the overall sort of tone of the market and psychology of our clients, it's very robust.

Clearly, there's been volatility around recently, but we haven't seen any issues or any cracks or any concerns or any worries that have been reflected in their budgets or in our sales to them or our dialogue to them at this point.

So we remain cautiously optimistic about our continued success with those clients.

Look, on the expense base and the rate of growth of expenses, our view -- we kept expenses in the 5 to 6 expense growth range when revenues were only 200 to 200 basis points above that.

Now that revenues are increasing, particularly subscription revenues, we want to deliver operating leverage, but we want to continue to invest in the business.

Everything we do basically gets expensed, and therefore, that will be reflected on a higher expense base and expense growth of the company.

We do not want to -- so let's say if we were to grow substantially higher than we currently are growing on the top line, we do not want to widen the operating leverage of the company.

Given the huge opportunities we have available, we want to take advantage of that incremental growth to share it with shareholders.

Part of that gets invested and then for reflected in EBITDA expense growth, and part of it gets dropped to the bottom line in operating leverage.

Yes.

So just to add to that a little bit.

As Henry alluded to, look, our priorities and focus continues to be driving strong top line growth and controlling expenses.

But as Henry said, look, we've got some great opportunities here, and we're very confident in our ability to execute.

We've got an excellent management team.

Our bets are paying off, and we've got a track record of high-return projects that are paying off: factors, ESG, fixed income helping drive multi-asset class.

So it makes sense that we kind of look at these high-return projects and execute as -- execute them as fast as we can.

Now if you look at the kind of ramp-up and the run rate in expense level, there are some nonrecurring-type things expected in the balance of the year, which I referenced, including some investments from the marketing side and particularly some severance, a little bit higher severance in Q4.

So we think that, that's the smart thing to do to kind of optimize the cost structure as we go into 2019.

Our next question comes from Bill Warmington with Wells Fargo.

I was going to ask you about the Analytics business.

Looks like the net new recurring subscription sales there are the strongest that we've seen so far this year.

So if you could comment on that.

And then also the -- this is your fourth quarter of 7% organic growth in Analytics and sort of with an outlook towards can you sustain that level?

Yes.

Thank you for the question.

So it is precisely because -- related to the question you're asking, that we kind of put an emphasis on that in my comments, my -- in the script.

So we feel increasingly confident that we have built the basis of the ability to have steadily increasing growth.

We have actually been relatively conservative in the way that we've communicated around that to you all, and we wanted to give some color as to the examples that are driving that.

So this is very much what I would call the accretion of functionality, the accretion of client focus, which we continue to believe will deliver more value.

So this is more of a steady story than a rapid change story.

But everything that we're seeing in terms of our client relationships, our pipeline and the nature of the Analytics we're adding to the pipeline leads us to believe that this will continue in the right direction.

Our next question comes from Manav Patnaik with Barclays.

Kathleen, I just wanted to follow up on that comment on the high-return projects, and I think I fully appreciate that.

I was wondering like outside of factors, ESG, fixed income, which are obviously the obvious ones, like what are some of the other ones in there that you guys are spending some of that money in.

Yes.

So I think that across each of our product lines, we have significant opportunities.

Kathleen, in her comments, I believe, had referenced some of our custom Index growth, where we're investing in that infrastructure in the Index business and, in general, our ability to deliver a range of different types of content, such as thematic indexes in the index world.

We have pretty significant investments in fixed income, which are cross-product lines.

So some of those are mostly focused in Analytics, where I reference them, also some new initiatives in Index.

We were investing in our platform in Analytics, which is initially building out for Analytics itself, that segment.

But as I referenced in my comments, it has positive impacts in things like ESG, where that content is going forward.

So I would say that within each of our product lines, we have some pretty attractive opportunities, many of which, I think, have been referenced over the calls in the last few quarters.

Got it.

Okay, that's good to hear.

And then just one other question for me.

So with the cash balance you have, it sounds like maybe buybacks remains a key priority.

But just curious, like what kind of deal would make you do M&A over a buyback?

It would be high return to the investment, to the capital outlay and a very strong, strategic focus.

And unfortunately, we're not seeing much of the former in terms of the properties that get sold -- are being sold at extremely high valuations, and therefore, we sit it out.

We're hoping that, at some point, market conditions will create opportunities for us to see better returns and coupled with very strong strategic focus on what we do.

But in the meantime, we spend a lot of time in the last 12 months looking at our strategic focus and found these 2 areas of the FEA, which is the commodities part, and the InvestorForce, and we had an opportunity to sell them to people that will make better benefit of it.

Our next question comes from Chris Shutler with William Blair.

On the guidance, it implies a sequential step-up in adjusted EBITDA expense sequentially, I think, of $6 million to $13 million.

What are the top 2 -- top 1, 2 items driving that increase?

And Kathleen, can you quantify the onetime items that are in that implied Q4 expense guide?

Yes.

So let me talk about Q4 first, and then we can go into 2019.

Yes, I mean, we got a little bit higher in terms of severance in Q4, a couple million dollars higher, and then some incremental investments, both technology and some marketing around our most widely used indexes.

In terms of implications then for 2019, I mean, when you think about the cost base and the ramp-up, 2018 to 2019, it's really similar to what we've talked about in the past in that you think about the cost structure that we have and our cost base being primarily people and technology and 60% of our sense of being an emerging market, when you kind of think about that and layer on kind of year-over-year merit, if you will, and investments that we want to do in all the areas that Baer just articulated, that's really the path when you think about a 2018 to 2019 walk.

We'll spend a bit more of time on this on Investor Day.

But it's very important to emphasize that we continue to be highly focused on a balance between continued margin expansion, which we want, we like, and investing in the business to capitalize on the significant opportunities that we have and will create higher revenue growth.

So it's a balancing out between the short term.

We do not want to be milking the franchise at all.

We want to be investing in the franchise.

We have been doing that even in the face of major margin expansion last 3 years, and obviously, it's been rewarded by shareholders.

That will -- we plan to continue on that balancing out, not to -- we're not planning to decline margins or anything like that.

We want to continue margin expansion.

But we -- if we grow faster, we will increase EBITDA expenses faster.

We will not keep them flat and, therefore, miss on the investment opportunities and have a major margin expansion that will feel us -- make us all feel great, including me as a big shareholder of the company, but take away the value creation in years to come.

Yes.

As Henry said, look, it's a balancing act, right, because there are several things that are important to us and that we're absolutely focused on and obsessed with, quite frankly.

And that is strong top line growth and continuing the momentum and the trajectory there, controlling expenses while also being able to fund the really good investments that we have and positive operating leverage over the long term and just smart capital allocation, making sure we're using our capital and cash and putting it towards the best use all the time.

And by the way, this is not a change of direction.

We're not signaling any change.

This is what we've been doing for the last 3 years.

Now we were more constrained in doing it when the rate of growth was lower, and therefore, we had to keep the rate of EBITDA growth lower than if we are growing faster.

But we're committed to continued margin expansion at the same time as, obviously, investing for even higher growth in the company.

Okay.

And then regarding the 3-year equity incentive plan.

As it comes to a conclusion here in the near term, what should we expect the new incentive plan to look like, at least at a very high level?

I'm curious if there will be a similarly heavy emphasis on total shareholder return for top execs.

Yes.

We like that huge alignment.

Me, as a shareholder that happens to be the manager of the company, I really like that complete alignment of shareholder interest and board interest and management interest in one objective, it's share price higher.

And therefore, whatever we end up doing in the next few years will be focused on TSR.

There is, obviously, a little bit of a focus in RSUs that are time vested and not sort of share price-driven in order to dampen that volatility in some of the members of the middle management team of the company.

But at the top of the house, including me, it has to be driven by complete alignment with shareholders.

So now the second question is whether we end up doing a multiyear plan or annual plan, I think it -- those are discussions that are going on with the board.

We have -- we want to align the incentive plan to the strategy.

The last -- in the 3-year plan had a -- the 3-year promoted shares were aligned to a 3-year strategy that we agree with the board, and it was very effective.

And we don't know yet if that's going to be similar or it's going to be annual grant.

But whatever it is, it's got to be a high level of sort of a manager-shareholder interest and a high level drive of alignment on share price.

Our next question comes from Toni Kaplan with Morgan Stanley.

Kathleen, in the past, you've talked about the downturn playbook.

And just given the volatility in the equity markets in October, did that trigger you to implement your downturn playbook?

Is that what's driving the 4Q severance?

Or basically, is -- are the severance actions more normal course of business?

Just any color on that.

Yes.

So Toni, let me introduce it, the concept, and then Kathleen can comment on the specific numbers.

The -- what we have been doing in the company is -- in our constant strategy is trying to understand all of our opportunities to service clients and grow the franchise and, therefore, create more shareholder value.

And in the process of doing that, we also review our organizational structure, our different management teams, are they in the right place, in the right seats and the right locations and all of that.

And to the extent that we don't see a complete alignment on that, we are taking actions with changes on the organizational structure or changing of the individuals.

So that what's driving.

This is not any different than we've done in prior years.

There's always an undercurrent -- an underlying amount of severance in every year.

This quarter, fourth quarter, will be a little bit higher because it just happened to a group, a lot of those changes.

But that is the underlying driver or philosophy on all of this.

Yes.

That's right, Henry.

Thank you.

So Toni, we're always looking at kind of the organizational structure, the cost structure and always questioning how do we do things better and more efficiently.

So there's always going to be a little bit of this sort of activity.

It's a little bit elevated in Q4.

But in response to your question about the downturn playbook and kind of -- let's think about that in terms of looking toward 2019.

We are also always looking at that downturn playbook and how do we strengthen it, how do we modify it, how do we enhance it.

And so as we think about that and we think about the possible scenarios and market conditions in 2019, it's very important to us that we kind of ensure that we are a nimble organization and able to kind of adjust up or adjust down for market conditions.

And so we're always kind of looking at and refining that downturn playbook and thinking about it in the context of what are the things that are kind of self-adjusting costs and costs that don't impact top line growth versus the things that you want to go to last, in other words, pacing of investments.

So that's kind of how we think about it, and we're always kind of looking at it and refreshing it to make sure we're ready to go.

I would just add something else, given that there have been a few questions on this topic is, clearly, any kind of market volatility, any kind of global economic potential slowdown or trade wars or tensions, we need to be humble about them and the impact on then -- on them.

But we want to stress to you, we are not seeing any changes to our business because of that.

And on the contrary, part of us think that those things present significant opportunities to enhance our franchise.

So we're not giving you an indication of we're concerned, we have problems or whatever.

On the contrary, we feel that -- and thus, those were the comments about the all-weather franchise.

We feel that this presents major opportunities for our clients to use our products.

Okay, that's helpful.

And just for my follow-up.

I know this has been asked before in a couple of different ways, but I just want to make sure I'm very clear on the message here.

So the last time you had an Investor Day, there was a pretty significant investment ramp-up so -- ramp-up in expenses and, basically, lower margins as a result.

And what I think I heard you say, Henry, is that now it's more that you're committed to expanding margins.

There will be some investments because you do have these growth opportunities, but we shouldn't really think of this as a repeat of 2014.

Is that the right way to think about it?

It's not a repeat of 20 -- whatever that was -- '14.

It's to give you an update on how we're thinking.

We haven't done one in a long time, tell you how excited we are about the opportunities that we see ahead of us, how we can increase growth of the top line commensurate with those opportunities and what are the investments that are required to achieve that in the content of an expanding margin.

Our next question comes from Joseph Foresi with Cantor Fitzgerald.

I was wondering, can you talk about maybe a shift in the demand environment?

Obviously, with the more volatility in the market itself, maybe some of your products would be a little bit more relevant and some less relevant.

Just trying to get a sense based on some of the shifting AUMs that we're expected to see and we have seen.

Sure.

I'll make a few observations.

As Henry said, clearly, we can't -- we don't have a crystal ball.

We can't see the circumstances, and we're not complacent.

But I think, actually, some of the examples that I gave of our most recent sales and the general direction of where we're headed is that most of what we do is infrastructural to our clients.

It's not highly dependent on market levels.

It is the way that they run their business, it's the content they use, it's the processes they use, it's the exposures they have.

So having been through this now several times, we had difficult markets in 2000, 2001, 2002, clearly, the financial crisis.

I feel quite confident that our products and the need for our products is very resilient in that context almost across-the-board.

The clear exception is, of course, those things which are linked to market levels themselves, which will, by definition, come down, linked to the market.

And then I think the other element is, clearly, in a sustainably difficult environment, our clients will -- there were 2 things occurred.

There was just generally cost pressure, looking everywhere for costs, and at the margin, that puts a little pressure on us, but it's not the nature of the need.

It's just the clients' push for efficiency.

And then finally, going even further, if consolidation in the industry accelerates, historically, we found that our major part of our cancellations can be consolidation.

But those are getting kind of well ahead of ourselves.

I think the most -- my bias would be from my view of this in the past and my current vantage point, that in the early period and in the short-term correction, we would have a tendency to be seen to be resilient compared to what's going on in the rest of the market and maybe some of our competitors.

And in fact, to that point, Baer, I mean, we've looked at -- we've looked back a decade and looked at the subscription growth each and every year during that time period, and it's been quite strong in every year.

Yes.

Got it.

And then just one kind of question building on that.

You talked about some of the trade-off of pricing for volumes, which I assume is market share.

In the environment where there's more volatility, will you start to feel that pricing pressure on your core business?

In some of the newer initiatives, are those coming in at lower price rates?

I'm just wondering, as we look back historically, in those volatile markets, does pricing become a larger issue?

And in some of the areas you're switching to, is pricing coming in a bit lower, again, to gain market share?

So as a broad observation across what we're doing, generally, the pricing is not coming in lower is the headline, right?

So the -- our pricing power is generally consistent, or even in various categories, as we've spoken before on some of these calls, our pricing power has increased, notably in Analytics, as an example.

So my sense would be -- and then if we go back historically, more of those things are linked to our competitive -- I would say, our competitive competencies at the time.

So going back, let's say, a decade ago, we had some quite a bit of pricing pressure on equity analytics, but that's because we weren't competitive enough in certain areas.

So my sense is, we're pretty strongly competitive in our main categories.

I do think that a tougher market always leads to some price competition, but for sure, we're not feeling that yet.

Our next question comes from Henry Chien with BMO.

So I wanted to ask about the wealth management opportunity.

If I'm hearing correctly, it sounds like that was a meaningful sort of growth driver for the subscription or index subscription business.

Is that sort of the case?

And is the dynamic there similar to the active asset management space and in terms of the adoption of passive?

And just any kind of color on what's going on there.

Sure, yes.

So let me try to structure my observations in the following way.

One, clearly, the wealth segment is, today, significantly smaller for us than the asset management.

Two, the growth rate is higher.

It's, I think, I believe, our highest segment growth by client segment in the last quarter.

We're investing more there.

Many of the trends that we've seen in other segments, notably the growth of Index products, increasing risk management and benchmarking, et cetera, are increasing.

So our strategy is to continue to invest there, and our plan and hope would be that you will see sustained growth in that segment on the quarters going forward.

Got it.

Okay, great.

And just kind of following up to some of the prior questions.

In sort of the more volatile environment, and I guess this is more of a high-level question, are you seeing an impact in how your clients are thinking about the use of passive?

Not really.

Yes.

The volatility has been so short that it's a very, very short period.

It hasn't affected structural behavior.

Our next question comes from Hamzah Mazari with Macquarie Capital.

My first question is just on productivity or efficiency net of investment.

I know you spoke a lot about incremental investment, but curious how you're thinking about productivity going forward in light of any initiatives, including One MSCI go-to-market.

I know you highlighted $0.08 in the quarter.

Just curious how we think about that number on a go-forward basis.

Look, we are extremely focused on that.

And the 2 examples there would be when you look at our headcount in the last 1 or 2 years in the -- headcount increase has been very modest relative to the sales and revenues of the company and the amount of innovation we've done.

And then secondly, our -- on the client coverage side, our productivity levels have actually increased, probably about 20%, 25% in the last 2, 3 years.

Yes.

So just on -- yes.

I can just add a little more color there in terms of how we look at it.

I mean, look, the culture here is that we're very, very careful about spending levels and always scrutinizing productivity and efficiency.

And you've seen us kind of make some great strides the last couple of years in terms of leveraging some emerging market talent, and you'll see us continue to do those sorts of things.

Great.

And just a follow-up question.

I'll turn it over.

Just on ESG, you talked about the business doubling in 3 years.

How do you think about that growth rate going forward?

I realize it's the law of large numbers.

Is the market big enough for the business to double again in 3 years?

Yes.

We can't, obviously, speculate whether it's going to double or not, but the opportunity is huge.

Our next question comes from Keith Housum with Northcoast Research.

Question regarding on the [All Other] segment, following up the ESG question.

Not much discussion of the real estate portion of that group.

I wonder if you could add some color to that in terms of how it's performing and what the expectations are going forward, perhaps as you're realigning the cost structure here going forward.

Yes.

So that -- clearly, the big driver of the Other segment right now is ESG.

Real estate beginning to have an uptick in terms of sales and profitability, but it's not yet in a position of making significant contributions to that segment.

But we're hoping that -- we're very optimistic that it will.

Got you.

And then Kathleen, just a little bit of housekeeping here.

Interest income has obviously ticked up for you guys quite well over the past few quarters.

Obviously, you got interest -- a rising interest rate environment, and you guys have more cash on the balance sheet.

But has there been a change to your philosophy in terms of your investments that's helping drive some of that interest income as well?

No.

It's really just the cash balances and just better execution on the -- and deals that we're doing.

No change in strategy there.

Okay.

So we should still -- what you see in this quarter and last quarter, we should see that continuing.

Yes.

Our next question comes from Vincent Hung with Autonomous.

Just want some clarification on your previous comments in relation to timing considerations relating to Index sales.

So can that be a function of the market environment at all?

If conditions worsen, does the signing get pushed out?

Or is it just issues where a contract gets signed a few days late?

No change with respect to the market environment.

It's just simply the number of renewals that we've negotiated in the quarter gave you a little bit of overgrowth compared to the prior quarter and the future quarters.

So it's just timing.

Got it.

And with the stronger growth in sales, more broadly, in recent quarters, is there any pull-forward, perhaps, from 4Q?

Or should we continue to expect that nice bump from 3Q to 4Q?

We can't -- I mean, we haven't done the call for Q4, so we can't be forecasting what's going to happen.

So I think it's not appropriate for us to say in a call like this what will happen in Q4 at this point, right?

We'll -- stay tuned to the end of January.

Our next question comes from Patrick O'Shaughnessy with Raymond James.

For the ESG business, do you think of that as a benchmark-type business with long-term pricing power?

Or as the business matures and more competitors come into the space, would you expect pricing to get more competitive over time?

Look, we're definitely trying to create the standards for measurement and investing in -- according to ESG criteria on one hand.

On the other hand, I'm not sure that there will be just one absolute standard to this.

There may be a few competitors in the space.

And whether that leads to pricing pressure or not, I don't think so.

I mean, a lot of our clients are following the MSCI kind of metrics, and we've had meaningful pricing power there.

But right now, we're very focused on penetration on that across the world.

Great.

And then maybe a quick one for Kathleen.

Just within the asset-based fees, I think there was a $2 million quarter-over-quarter decline in your non-ETF, that institutional passive category.

I know there's a bunch of moving parts in there, and some of that is kind of recorded on a lag.

But can you speak to that sequential decline that we saw in the third quarter?

Yes.

I mean, you're exactly right.

There's some timing stuff going on.

There's a one-quarter lag.

If you look at run rate, year-over-year run rate's up 24%, lots of new licenses.

It's for the business that we feel really good about the trajectory and the continued growth here.

This concludes today's Q&A session.

I would now like to turn the call back over to Andy Wiechmann for closing remarks.

Thanks, Hermione, and thank you, everyone, for joining us today.

We really appreciate the continued support and belief in MSCI's story.

We look forward to keeping you posted on our progress.

And as always, please don't hesitate to reach out with any additional questions.

Happy to be helpful wherever we can.

Thank you, everyone, and have a great day.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program.

You may all disconnect.

Everyone, have a great day.