明晟 (MSCI) 2020 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the MSCI Second Quarter 2020 Earnings Conference Call.

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

I would now like to turn the call over to Salli Schwartz, Head of Investor Relations and Treasurer.

You may begin.

Thank you, operator.

Good day, and welcome to the MSCI Second Quarter 2020 Earnings Conference Call.

Earlier this morning, we issued a press release announcing our results for the second quarter 2020.

This press release, along with an earnings presentation we will reference on the call as well as a brief second quarter 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 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 pages 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 revenue.

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 Linda Huber, our Chief Financial Officer; Andy Wiechmann, our Chief Strategy Officer, will also join us for the Q&A portion of the call.

(Operator Instructions)

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's second quarter performance once again demonstrates the resilience of our franchise and the mission-critical nature of our content, analytics and technology applications for investors, particularly during these times of market uncertainty.

Specifically, today, we reported solid operating revenue growth of 6.2%; strong adjusted EBITDA growth of 11.8%, reflecting our ability to tightly manage expenses; and strong adjusted earnings per share growth of nearly 15%.

As you are aware, and we have discussed in these calls, we have a number of strategic initiatives underway at MSCI.

First, we are expanding our coverage of asset classes to include areas in fixed income and private assets.

Second, we are creating new products that can apply to a specific asset class or across multiple asset classes.

These new products include content in ESG, climate change, factors, risk models, thematics and futures and options, just to name a few.

Third, we are broadening our reach to newer client segments like wealth managers, insurance companies and corporates.

And fourth, we are transforming our technological capabilities, not only to benefit our clients but also to enable our employees to operate even more effectively in the virtual world we're living in.

We have made significant investments in these initiatives, and I'm very pleased to report that these investments are yielding strong results.

During our call this morning, I would like to highlight 3 areas.

First, in ESG and climate change, we have continued to expand our content, including research on key topics, additional ratings coverage and new indices in both equity and fixed income and risk models that integrate ESG and climate change variables.

These investments in ESG and climate solutions are providing significant returns.

In the second quarter, our ESG franchise across the whole company performed very strongly, reaching a run rate of $174 million.

ESG research itself reported its highest ever quarterly subscription sales.

And in ESG Indices, AUM in equity ESG and climate change ETFs linked to our indices almost double year-over-year, reaching $55 billion at the end of the quarter.

We are encouraged by investors' increasing adoption of our tools to effectively integrate ESG and climate change criteria as a core component of building resilient portfolios.

And we believe our ESG solutions have the additional benefit of driving transparency and creating standards for many market participants.

As you know all too well, we have long believed sustainable investing is a critical part of the long-term investment process.

Our early moves in this area have given us substantial leadership and competitive advantage, which we will continue to capitalize.

A second area I would like to highlight is index futures and options.

We are helping our clients build the various elements on an -- of an MSCI ecosystem of financial products with deep liquidity on a wide range of market exposures.

This ecosystem includes ETFs, listed futures and options, OTC swaps and options and structured products, all fitting and benefiting from one another.

Recently, and as part of this important initiative, we significantly expanded our relationship with Hong Kong Exchanges and Clearing, further aligning MSCI with a global exchange leader in the Asia time zone and enabling deeper and more liquid markets for MSCI-linked futures and options.

We believe Hong Kong provides access to and the benefits of a large client base, including Mainland China investors, a significant pool of liquidity and an ecosystem of both listed and non-listed derivatives.

And the third area that I would like to highlight is our investment in our technological transformation.

Last week, we entered into a partnership with Microsoft that will not only strengthen and scale our infrastructure but also continuously improve our client experience.

Our transformation through Microsoft Azure includes an advanced global network of data centers, a fully integrated cloud infrastructure to provide massive scale and product delivery and sophisticated artificial intelligence and national language processing capabilities.

We intend to take full advantage of all the benefits that this partnership can bring to MSCI.

Facilitated by this partnership with Microsoft, we will be able to help investors more swiftly and efficiently manage data and understand better the drivers of risk and return in their portfolios.

Despite the ongoing macroeconomic uncertainty, we will continue to selectively invest in the highest-returning areas of our business, both to further position MSCI for growth and to drive operating efficiencies.

As you can discern from my remarks, we continue to execute well and obtain significant returns in the areas we're making strategic investments in.

I would like now to turn the call over to Baer to go over our efforts in more detail.

Baer?

Thank you, Henry.

I'm quite pleased with our team's high effectiveness in working completely remotely with clients this past quarter.

Our results clearly demonstrate our success in adapting to a virtual engagement model.

We also continue to roll out new content and capabilities across the firm.

In June, we launched Real Estate Climate Value-at-Risk, a forward-looking tool that provides real estate investors and managers with the ability to evaluate and review climate exposures and concentrations across their portfolios.

We also launched Index Metrics, a service to provide investors the ability to evaluate, compare and monitor strategies linked to MSCI indexes.

We introduced a mobile app on iOS to support investors with real-time access and performance information for MSCI indexes.

And in May, we made 36,000 ESG fund ratings publicly available on msci.com and launched the MSCI Index Profile tool to provide better access to ESG metrics for both ESG and non-ESG Indexes.

During the quarter, we drove new recurring subscription sales growth of 16% against a strong second quarter last year and amid the current uncertain macroeconomic backdrop.

ESG, in particular, reported its highest quarterly subscription sales on record with growth of 93% over the prior year.

Index recorded over 20% higher sales growth, featuring strong growth in nonrecurring sales, which benefited from increasing demand from broker-dealer and bank clients for bespoke OTC derivatives and structured products linked to MSCI indexes.

Analytics new subscription sales were also strong, growing 10%.

Offsetting some of the strength in sales was an elevated level of cancellations, particularly from certain bank and hedge fund clients.

While a modest number of the cancellations could be attributed to COVID, particularly among hedge funds, most are the result of ongoing restructuring within our clients' businesses.

Overall, MSCI's retention rate for the second quarter was approximately 200 basis points lower year-over-year, a respectable outcome, allowing for the context.

The retention rate in our Real Estate business was notably strong at 96.2%, which helped offset some of the weaker sales.

Looking forward, while we do not have any indication at present in the pipeline that elevated cancellations are a trend, this environment is unpredictable and could be subject to change.

I'd like to spend a few minutes on our Index segment.

In the second quarter, our clients launched approximately 30 new ETFs linked to MSCI indexes.

The vast majority of these were ESG and climate products.

In July, 17 MSCI index future contracts began trading on HKEX, with an additional 20 expected to launch in the near future.

We also extended our agreement with the Singapore Exchange for the listing of both futures and options on the MSCI Singapore Index.

Year-over-year, futures and options run rate grew 85%.

However, volumes and contracts created for futures and options linked to MSCI indexes declined sequentially as we observed a reversion to normal levels of market volatility versus at the beginning of the year.

As you are aware and can see in our results this quarter, we have remained very disciplined in our expense management in this environment.

We have nonetheless continued investing in our business, as Henry noted.

For 2020, we targeted and have been executing against a $140 million investment program to change the business.

These investments span across Index, where we continue to build our infrastructure and functionality to enable clients to get more sophisticated and timely indexes; client coverage, where we made select key hires to our global leadership team; ESG, where we have a range of investments, for example, in improving our climate capabilities; and select other high-return opportunities that support our business growth and enable greater operational efficiency.

Before I turn the call over to Linda, I thought it might be helpful to provide an update on my client segment commentary from last quarter.

Asset managers continue to drive the largest mix of new subscription sales across MSCI through both new and upsell opportunities, and this past quarter had a retention rate of 94.6% despite continued industry pressures facing active managers.

We're seeing ongoing traction in client segments we have targeted for growth including, for example, wealth managers, where we have more than doubled new subscription sales year-over-year, and corporates, where we're beginning to put dedicated sales coverage.

We have also had success increasing our footprint with asset owners who are particularly active in implementing climate strategies across asset classes, providing MSCI with attractive opportunities for our climate solutions.

Finally, for hedge funds, we are seeing 2 different cohorts.

The crisis has pressured some funds to exit their strategies and/or restructure, sometimes leading to cancellations with MSCI.

Others have performed exceedingly well and, in some instances, are inclined to acquire more of MSCI's content, analytics and technology applications.

Hedge funds have, therefore, been both a source of higher cancellations but also of significant recurring subscription sales growth.

As we enter the second half of 2020, while we continue to observe tighter transaction and procurement controls from certain clients, we remain confident in the overall long-term trajectory of our franchise.

Let me now turn the call over to Linda, who will discuss more specifics of our quarterly performance.

Linda?

Thank you, Baer, and hello to everyone on the call this morning.

The second quarter was another quarter of solid execution for MSCI.

Operating revenue grew just over 6%, and recurring subscription run rate grew nearly 10%, reflecting strength in Index recurring subscriptions and ESG as well as more modest growth in asset-based fees, Analytics and Real Estate.

Turning now to assets under management.

Assets under management and equity ETFs linked to MSCI indexes ended the second quarter at $825.4 billion, recovering nearly $116 billion from the end of the first quarter.

All of this AUM improvement came from a rebound in market levels across all exposures.

During the second quarter, we saw net cash outflows of $1.5 billion, driven by ETFs with international exposures that were only partially offset by positive inflows into ETFs linked to MSCI indexes with U.S. exposures.

Notably, sequential cash inflows into equity ESG and climate ETFs linked to MSCI indexes totaled $10.4 billion.

Additionally, equity ETFs linked to MSCI Factor Indexes saw $2.9 billion of inflows from the first quarter.

As of July 22, assets under management linked to MSCI Indexes has further improved to more than $880 billion.

I'll turn now to asset-based fees, which were up slightly at 0.4%.

We recorded substantially higher year-over-year asset-based fees in futures and options linked to MSCI indexes, which grew more than 90% to $8.6 million in the quarter.

Asset-based fees from non-exchange-traded funds linked to MSCI indexes were $26.8 million, growing approximately 7%.

Year-over-year, the relatively flat AUM levels and lower basis point fee levels resulted in a decline in asset-based fees from equity ETFs linked to MSCI indexes.

Sequentially, the basis point fee on equity ETFs linked to MSCI indexes decreased 0.04 basis points, predominantly reflecting a mix shift into funds with lower total expense ratios.

We ended the second quarter at 2.67 basis points.

Our quarter-end ETF AUM linked to MSCI indexes was higher among U.S. exposures sequentially and year-over-year.

Our international market exposures in emerging markets and developed markets outside the U.S. were down year-over-year, but both have increased quarter-over-quarter.

And I'll turn now to our adjusted earnings per share growth year-over-year.

Higher subscription revenue was the largest driver of our almost 15% growth in adjusted earnings per share.

Excluding the impact of FX and including depreciation and amortization, total expenses increased slightly.

This was offset by our tighter expense management in the quarter, including the hiring freeze we noted during our last earnings call as well as significantly lower travel and entertainment and other non-compensation expenses.

The balance of our adjusted earnings per share growth was driven by favorable tax and foreign currency impacts and a lower share count.

These were offset by higher interest expense associated with the higher debt balance during the second quarter as well as lower interest income on cash balances.

And turning now to our balance sheet.

We ended the second quarter with a cash balance of approximately $1.4 billion.

And in May, we issued $1 billion of notes due 2031 at a coupon of 3.875% and used $800 million of the proceeds to redeem our 2025 notes that had a coupon of 5.75%.

We remain very confident in our capital position, which continues to enable us to invest selectively and strategically in our businesses and to return capital to our shareholders.

In the second quarter, we repurchased $31 million of stock and paid approximately $57 million in dividends to our shareholders.

And yesterday, the MSCI Board also approved a dividend increase of 15% to $0.78 per share for the third quarter.

This is in line with our payout target of 40% to 50% of adjusted EPS.

Now moving on to our outlook for full year 2020.

As we announced in our earnings release earlier today, we are reiterating most of our lines of guidance as we continue to invest in our business for growth and operating efficiencies.

We do now expect a lower effective tax rate for 2020 in the range of 16% to 19%.

And for free cash flow, we now expect to be toward the upper end of our guidance range of $540 million to $600 million, primarily reflecting the lower effective tax rate range as well as stronger cash collections.

Full year interest expense is still expected to be approximately $158 million.

However, the current low-rate environment is also likely to drive quarterly interest income earned on cash balances to be at similar levels as this quarter for the foreseeable future.

In closing, I want to reiterate Henry and Baer's confidence in our business model, people, operations and opportunities.

We have a solid balance sheet and ample liquidity.

While the range of economic and macroeconomic outlooks remain broad, we will continue to take proactive management decisions in the best interest of our employees, shareholders, clients and other stakeholders.

And with that, operator, please open the line for questions.

(Operator Instructions) Our first question comes from Toni Kaplan with Morgan Stanley.

The retention rate stepped down a little bit this quarter, but the new sales were very strong, especially in ESG and Analytics.

And I think that's the opposite of what I would have expected just in the current environment.

So you mentioned restructuring within client businesses.

Just wondering if you're seeing that continue into the third quarter.

And just any sort of extra color on the drivers of retention and new sales that you were seeing this quarter and if those are continuing.

Toni, Baer here.

So look, I think that the sales numbers reflect the positive actions that we were able to take in the quarter and the fact that we were really up -- able to get up and running very strongly and continue our client outreach activities, et cetera.

So clearly, the pipeline for some of the items is -- it was longer.

So I'm not suggesting that business was all originated within this quarter or the tail end of the previous one.

But overall, the -- we found that we really had a pretty strong quarter for sales activity, and we continue to see that, and we're pretty pleased about it.

So when we look at the cancels, as we've mentioned a bit earlier in our comments, the -- a certain amount of those were more related to the current environment, as perhaps you had thought, notably a little bit on the -- notably on the hedge fund side with small or medium hedge funds and a few other categories.

But the sort of restructuring of client business that we allude to were typically longer-term things.

There were a few cases of both sell-side and asset manager clients removing themselves from certain lines of business.

And those things were not necessarily things that had occurred because of COVID or short-term market circumstances unlike the hedge funds.

There were some structural cases.

One example was a sell-side firm that had reduced a lot of its activities in equities, and similar things of that kind that were happening over time.

And then additionally, as always, there are a few -- there's a -- I would say, those were the larger percentage and a smaller percentage of normal competitive type of things.

So looking forward, I would say that our -- there are 2 things, which are a little bit in contradiction to each other but not entirely.

The first is, based on our current view of the pipeline, we do not have strong evidence that cancels will continue in a bad direction.

We don't have that evidence, but I just want to reinforce that point.

Equally, in view of the extraordinary circumstances we're in, which include the fact that the pandemic is certainly not over, unfortunately, in the United States.

And while it appears somewhat better in other parts of the world, it could recur.

And the macroeconomic indicators are clearly very poor, and a number of these sort of supporting -- the macroeconomic support for individuals and companies will cease towards the tail end of the year.

So those things mean that we continue to reiterate what we said last quarter that we expect that the cancels will likely continue to be a challenge, but we don't know where that will come from at this stage.

We're just being cautious in view of the environment.

So that's kind of a little bit of a summary for you there.

That's very helpful.

And hopefully, on a brighter note, could you give some additional color on the strategic alliance with Microsoft?

Is there a way to quantify -- I know you talked about quicker speed to market on some new product development.

And so any sort of quantification would be helpful.

Sure.

So look, by the way, the brighter note also did include sales, right, just to reiterate that.

We were pretty happy about the outcome.

And in view of how we -- with the extraordinary changes we went through during the quarter, we really do view that as a positive.

So look, on Microsoft, I'm very excited.

Spent a fair amount of my personal time on this along with Jigar Thakkar, our CTO.

So there's both -- the element, if you want to call the mechanical element of the cloud migration, there's enormous amounts of things that Microsoft can do with us in terms of creating efficiency and speed to market, notably in our DevOps, which are on different standards because of history across the company, where we are already seeing in certain categories that we're just bringing software to market much more quickly than we were even 6 months ago because this relationship with Microsoft has already started in a few areas such as that.

We also think they can do help us a lot on our internal, what people typically call corporate technology, where there's a lot of efficiencies we can gain.

And then additionally, 2 more categories, one is with ESG.

We think there's some really interesting things there in view of Microsoft's global touch with corporations and the huge focus that corporations have on ESG.

And then finally, with advanced technologies, which, by the way, one area we're using a lot of those advanced technologies such as AI, natural language processing, et cetera, is in ESG, but also in other data operations, we think that they can bring a lot of value.

So it's really a holistic thing.

We've -- these discussions have been going on for quite some time, and we're delighted with the outcome.

And we think this will be a great deal for MSCI and a great partnership with Microsoft.

Our next question comes from Manav Patnaik with Barclays.

Maybe I can just follow up on that question.

And if you guys could just maybe refresh and let us know, you called out the ongoing technology transformation.

So maybe you could just give us a kind of snapshot of where MSCI is today and what that technology transformation actually means or where you're heading towards.

Sure.

Okay.

So just carrying on from my previous observations.

So look, one major theme in this is creating both innovation and efficiency across MSCI.

So because of the various -- the history of some of the acquisitions that we've done over time, we've had -- we have a lot of different applications in front of clients.

And those -- we're seeing a path where we're creating much greater commonality in the underpinnings of those, both in our data environment where we've already made a lot of progress in the last few years, but we think we can make even more progress going forward.

In our client applications, where I think the look and feel of the client experience with MSCI technology in, let's say, even a year from now, let alone 2 or 3 years, will be much more uniform, much more standard and much more user-friendly.

We're also -- so data is the first one.

The client experience is the other.

And then I think, as I said, the third one is in terms of the way that we operate internally.

All of our processes, which link from the client through the client coverage organization, through to finance, those are also an area where we see a lot of efficiency coming.

So just as we said a number of years ago, going back even 4 or 5 years ago, that the One MSCI story was both a client-focused story, and I think we've shown that by the unified segments we've started to create with ESG and with factors.

So I think we're on a kind of a second wave of that going forward, and technology is a huge enabler of that.

Got it.

And maybe just a quick question around your expanding client segments that you called out.

I mean what is typically the entry sale to get into an insurance company or the corporates, for example?

Is it different from the traditional?

I just wanted to get some flavor there.

Yes.

So the -- in terms of our Plan segments, we traditionally have been very strong in pension funds, clearly, all forms of asset managers, long-only and long/short asset managers and banks and broker-dealers.

So we want to expand further with the banks and the broker-dealers, especially on the heels of all these listed futures and options to help them create a large variety -- to license our indices to create a large variety of structured products and OTC swaps and OTC options and the like.

On insurance companies, we have been, in the past, a bit challenged in penetrating insurance companies for their own principal account, not necessarily only their asset managers but their own principal accounts, because we were not as strong in fixed income in our portfolio management.

And as you know, insurance companies have a very large percentage of their assets in fixed income products.

As we have been launching fixed income risk models, fixed income indices with ESG overlays and factor overlays and the like, that presents a significant opportunity for us to expand into life insurance companies as well as with our Real Estate product line.

On corporates, the big impetus right now is ESG.

We already are collecting a meaningful amount of data from corporates in terms of their disclosures about ESG and specifically on climate change, which we send back to them to review and analyze.

So there's an ongoing series of operational relationships that we're developing with them.

And we're now looking to sell them data sets for ESG for them to understand their own ratings and compare themselves to each of the other participants in their industry on ESG and on climate change.

Eventually, this partnership with Microsoft will be in another direction to see if we can create a bit of a data platform that will benefit corporates and investors alike.

Our next question comes from Alex Kramm with UBS.

Quick ones from me, I think.

On the expenses, Linda, you didn't change your guidance, but it's still fairly wide.

ABF is doing much better than it did a quarter ago.

So I assume to push up expenses a little bit, too, in terms of performance comp, et cetera?

Or where do you see the remainder of the year shaking out given how business is doing right now?

Sure, Alex.

As you noted, we've done a pretty good job of expense management.

We have been able to do a number of things, including maintaining the investments that we're planning to make in the company at about $140 million.

And everything that we've talked about on the call today is already baked into the expense forecast.

So nothing is incremental.

Part of this will hinge on how the rest of the year looks, and that's why we're leaving a range that might be a little bit toward the wider side.

And performance has been pretty solid, given everything that we're facing.

So we continue to be very selective about hiring.

We continue to be very focused on our expense base.

T&E, of course, is reduced sort of around $2 million a quarter, given that we're largely staying in place right now.

So I think we'll keep that range, and we'll see how the back half of the year comes together.

But we feel pretty good about everything that we've done and the way the business is running right now.

Okay.

So it's too early to not just any sort of lower end, higher end or something like that at this point, right?

Yes.

I think so.

And then maybe for Baer, I mean, you noted the strong ESG sales first quarter.

I think you talked about a variety of different things.

But can you maybe just force-rank kind of like the -- where the sales came from in terms of like largest buckets of new sales, what kind of products?

And that's particularly on the subscription side, obviously, not the Index side.

Yes.

So the pattern of the sales has been pretty consistent.

So we continue to have -- heavily focused on the ratings data area.

That's the really main driver of the sales.

The area where we continue to see a pickup is in climate.

And I would say that the discussions in climate, they have increased very -- fairly significantly in the last 6 months, including during -- with all client types.

And so all those things take a little bit of time to come through and become more material.

But I would say that the main story remains the broad one of going deeper and broader with clients.

And look, the one element that I would highlight that is probably -- first of all, we had a very large sell-side deal during the course of the quarter.

And I would say, generally, the discussions that we're having are going more broadly with the sell side as well as the -- traditionally, the asset managers and the asset owners.

And that, in turn, is -- and I know you mentioned that it was mostly on the subscriptions that I'm -- that you asked a question about, but I do think it's important to note that, that is also heavily linked to the various financial products, be they structured products, ETFs, where you saw that we continued to have a lot of issuance.

Because in turn, those people who deal with the -- with those -- with creating those products, in turn, they need more data, and they need all of that for their infrastructure and, sometimes, for creating their own ratings as well.

So that's kind of the pattern that we're seeing and very broad and across the board.

And I would say, still primarily heavily in the Americas and in Europe, but we're putting more focus on Asia and putting more client coverage resources there.

And we hope that we'll see more coming from there in the second half of the year.

Our next question comes from Bill Warmington with Wells Fargo.

Price has historically been an important part of revenue growth for the subscriptions in Index, and I wanted to ask how you're finding success or if you're finding success in continuing that trend in this environment.

I think it's the same.

No difference in the pattern at this point.

The source of additional revenues or additional sales that's coming from price versus volume continues to be the same mix.

So nothing really new to report there, Chris (sic) [Bill].

Okay.

So for my follow-up question, you'd mentioned the retention rate on the Real Estate was strong at 96%, but the organic revenue growth was down about 10%.

I just wanted to ask what -- that seems like a disconnect.

I wanted to ask if there was perhaps a volume component to the model?

Yes.

So look, I think there's one sort of, if you like, mechanical challenge we've had.

We've been somewhat understaffed in Real Estate client coverage.

We've now almost entirely remedied that.

And those people take a while to come on board and be trained, et cetera.

I think we may still have one open head count for Real Estate sales, but we're pretty much now got all those people on board.

Most of them have -- not entirely all of them are out selling yet, but most of them have transitioned into productive roles.

So for sure, we would hope that on the sales side, that would be the major change that would create positive movement there.

I think the retention rate is, I think, really a positive reflection of the enormous efforts that the Real Estate team has made in the last year, reaching out to clients.

And we've actually had, I think, a pretty good quarter overall for, let's say, our research and thought leadership outreach to clients.

Research -- Real Estate did a particularly excellent job with many client panels, so an MSCI research person and a client, and a lot of interest in all of that.

So I think that the general client satisfaction that we're seeing in Real Estate is reflected in the retention rate.

So look, we'll see.

Clearly, in this environment, Real Estate as an asset class could be challenged a bit.

But I think they're quite different drivers.

One is more longer term, the retention rate is more longer-term efforts, and the soundness of the business.

And then the other one was a little bit just short staffing in sales.

And then finally, there was just a little bit more technically, the -- we had a slight drop in the revenue was due to some timing of deliveries and some FX stuff.

But that's a little more of a marginal point-in-time thing.

Our next question comes from Craig Huber with Huber Research.

I wanted to ask on fixed income.

In the past, you guys have described your run rate of revenues and fixed income being less than 5%.

Just want to hear, if I could, what you guys view as the opportunity there, both the analytics area as well as your industry business long term.

I mean, for example, in 5 years, is there sort of a number in your mind of what percent of revenues is aspirationally fixed income could be revenues?

Could it be 7%, 10%?

How are you sort of thinking about that?

I've got a follow-up.

Yes.

So we're very excited about our are significant foray into fixed income portfolio management, analytics and index.

And notice that I say portfolio management because we traditionally have been fairly strong in fixed income risk and fixed income performance attribution for the middle office, the central risk management office of many of our clients.

The areas that we see a lot of opportunities are, to begin with, is fixed income indices, but not in the traditional sense of issuance-weighted or market cap-weighted indices but more with an overlay of ESG on those fixed income indices and factors or a combination of ESG and factors.

And that's an area that we just launched a wide variety of indices in the last, say, 6 -- 8, 9 months.

And there is a good pipeline of licenses for them in ETFs and other passive products and structured products and the like.

So I think that -- obviously, that takes time to build up into a large revenue source, but we're very excited about that.

We're also very excited about the fixed income analytics, particularly the new generation of factor models that we have launched in fixed income, which obviously feed into the factor indices and fixed income.

And that's an area that we're putting quite a lot of effort.

Also, liquidity metrics has been a big driver of sales in Analytics, and that has always a fixed income component associated with it.

Lastly, fixed income analytics itself, not only content in terms of the models, the factor models, but also on the workflow tools and the like.

So that's another area.

We think that, clearly, a company like MSCI with the footprint that we have and the client base that we have, not to be one of the largest providers of fixed income analytics tools and indices in the world, is not great.

We think that there is, therefore, quite a lot of runway in that direction.

I also want to ask you on the futures and options side as you think forward here about investing in that business.

Can you just touch upon on the opportunity there, in particular as you sort of expanded your various relationships, I guess, around the world with various exchanges out there?

But can you just touch on the opportunity on futures and options long term?

Well, it's a very, very large and fairly immediate opportunity.

By immediate, meaning, as you have seen, the run-up in the run rate, not only obviously based on the volatility that we saw, but much more importantly, the normal volumes and the repricing of a lot of our licenses.

So we started on this about a year ago, and we reported that the first agreement was done last year in North America.

The second agreement was done in Europe, and this is the third agreement now in Asia.

So we now have the complete sort of 3 major regions of the world.

We have smaller agreements with smaller exchanges in emerging markets, but the big ones are in place.

And that's going to be big because, not only the market for multi-country, multicurrency equity index futures and options is developing significantly, but also the structured products market.

The other benefit of all of this is that the growth that we do here is extremely profitable growth.

Because clearly, this is all IP that has been created already.

And the cost associated with all these licenses is the team -- the structure in, as I said, the over-the-counter team and structured products team in our broker-dealer client coverage to license our indices and, obviously, the futures and options team, but there's no cost of goods sold, so to speak.

It's all -- it's highly profitable.

So this would be hundreds of millions of dollars in revenue in the next 5, 10 years, right?

Our next question comes from Chris Shutler with William Blair.

On expenses, they grew less than 2% year-over-year in the quarter.

Linda, you mentioned $2 million a quarter of lower T&E impact, which would help reduce expense growth by about 1% per year.

I know that you're slowing the -- you did slower the hiring, but it looks like developed markets' employees are still up about 4% year-over-year.

So maybe just talk about where you have cut back expenses and where you are finding efficiencies.

Sure.

The most important part of this is we've been, as we said, very, very selective with hiring.

And you can probably see that the balance of our employees are still very much located in emerging markets versus developed markets.

So we're managing everything very closely.

And in addition to the head count, which still generally has to run through Baer and Henry to be approved for hiring, we are thinking about discretionary expenditures on consulting fees, projects, things like that.

So with all of that, we've been able to manage our expenses pretty flat to the same quarter last year, which has been a pretty great achievement.

At the same time, we're focusing very hard on our cash flow.

You'll note that we've been able to move our cash flow guidance up toward the high end of the range, which is a really good thing.

That's dependent on the tax rate being lower, as we talked about in guidance.

And then also the fact that we're doing particularly well with our collections.

We're being very careful about our working capital and our collections.

So that's been very, very helpful.

So hopefully, that gives you enough color, but we're quite proud of what we've been able to do on expense management, particularly this quarter.

Okay.

And then on a different topic, I want to come back to direct indexing, just because it is so kind of topical or increasingly topical these days.

And I know, Henry, you've talked about this in the past, but I just want to kind of come back to it and better understand the puts and takes for MSCI.

I mean I would think from a -- the negative would potentially be for your fee rates if comparing versus your average ETF fee rates today.

But on the other hand, if more assets are indexed against your indexes, that's clearly a good thing.

So is this just another example of potentially trading price for volume?

Look, it's -- Chris -- and we now have Chris.

I'm sorry to Bill that -- I thought it was Chris asking the question earlier, but it was Bill.

So look, I think the answer is the same, which is whether it's direct indexing or whether it's self-indexing or whether it's third-party indexing like [COS], at the end, the overriding philosophy of MSCI is that we're not in the business of creating indices.

We're in the business of helping our clients build better portfolios, which happens to be with our branded proprietary indices.

But if the direction is going to be that they want to build a lot of their own indices to build their own portfolios, we will rent our entire infrastructure to be able for them to achieve the same purpose of building portfolios.

And the -- and therefore, there is a wide variety of clients that if they wanted to do that, they're more than happy to rent the entire infrastructure.

We probably will make more money renting the entire infrastructure than just licensing the end product that comes out of that infrastructure.

So I don't -- we don't see that as a threat.

We actually see that as a big opportunity.

And we have a number of clients already that they're doing that, and we've been actually pushing other clients in that direction, but it's slow going.

Baer, you have some more comments on that as well?

Baer, I think you're muted.

Yes.

The other point I would add to that is that the direct indexing opportunity actually does involve benchmarks, not like it doesn't need them.

And additionally, the -- typically, the people who are involved need a lot of other MSCI tools.

So we were actually looking at some very interesting opportunities.

As Henry said, we're in the portfolio -- we're helping people build better portfolios.

And precisely the type of people involved in this are heavily quantitative, use a lot of different models, use a lot of different portfolio software.

So we don't really view it as a threat to Index that we typically view it as also a big opportunity in other firm.

And by the way, one of the things that we're beginning to embark upon is the next generation of our, what we call the index factory, going back to the technological transformation that we talked about earlier, is how do we create an index factory that lends itself to all sorts of use cases similar to the one we're just talking about in helping our clients build better portfolios through indices.

Our next question comes from Henry Chien with BMO.

I wanted to ask a little bit more about the planned $140 million in investments.

I'm not sure if you talked about it before, but just wondering if you can give an update on the kind of key areas that you're focused on and any progress so far in those areas.

So let me start with the broad landscape, and then Baer will comment in some of the specific areas of investing.

Yes, we traditionally haven't mentioned the numbers.

So if you think about $140-plus million out of an expense base of $700 million to $750 million, that gives you a pretty sizable part of our expenses allocated to this.

So the $140 million can be divided up.

More or less 80% are operating expenses, and those are the ones that are compared to the 700 -- $750 million.

And 20% are capital expenses -- capital expenditures.

And all of this is baked into the guidance that we gave you in expenses and capital expenditures at the beginning of the year.

So no change from any of that.

We see enormous -- really, really enormous opportunities for very high-return investments in our company with our clients.

The win is in our back in so many different areas, whether it's more indices, whether it's more risk models, whether it's more ESG or climate change, private asset classes, of course, fixed income in a variety of different flavors, as I've mentioned before.

When you -- when we tally up many of these investments on a priority, many of them are investments that are in the triple-digit returns over a shorter period of time, meaning 1 to 3 years.

So we're not talking about long payoff and relatively low return.

These are significant.

And the reason for that is because a lot of these investments are made already on top of an existing infrastructure.

So for every dollar of incremental revenue that we can get out of this investment, we increasingly have to put less dollars in incremental cost associated with it.

So it's very much of a virtuous circle of success in these investments.

And Baer, do you want to walk through a little bit of the breakdown qualitatively?

Yes.

So I think -- so Henry was fairly comprehensive there.

So just a few maybe other slight ways to sort of skin the cat as it were.

So the first one is -- well, actually, first is an overriding observation, and Henry alluded to this, but we are extremely disciplined in looking through all the expected returns on all of our investments.

And at the beginning of this period when we briefly slowed down some of them and paused at the beginning of this crisis, we actually kind of refreshed and reexamined the premises of all those things, which we had not yet started investing in.

And so I think we're pretty confident about our process and trying to be cold-blooded at looking at the return profile.

The 3 big buckets, if you think about it functionally, are in client coverage in the product areas for typically new feature functions and in technology.

I alluded to some of those technology things earlier as it relates to the Microsoft partnership and some of the earlier comments I made about technology.

And those, in turn, have a fairly large overlap with analytics, in particular, where we think we can drive more sales through both a greater efficiency, speed to market and some of the additional content that Henry alluded to, such as fixed income that we discussed earlier, and other analytics.

In turn, we're making significant investments in the Index infrastructure and building what we're -- internally, we have kind of a jargon for it, which is Index 2.0, which is a new world of client experience for Index, including, again, in this context, linking it to what we said earlier, when we talked about direct indexing, when we talk about helping clients build better portfolios.

It's that whole infrastructure of customized indexes, complex indexes like -- such as thematics and all of that.

Clearly, ESG is a critical category.

And we continue to invest in ESG, both technology and content.

And so those are some of the big buckets across the board.

And look, clearly, we don't have a crystal ball.

But we're very -- I think, fairly confident about at least the process we've been through to ensure that we're allocating capital to what we believe will be, hopefully, strong returning investments.

Our next question comes from Keith Housum with Northcoast Research.

In terms of the Microsoft arrangement, can you conceptualize perhaps how are you thinking about it in terms of, is this a net cost?

Or is it going to be a net savings, I guess, over the next several years?

And if it's a net savings, are you reinvesting back in the business?

Or does that flow to the bottom line?

Yes.

So they are -- there are 2 parts, if you want to think about it of the -- or 3 parts of the Microsoft partnership.

The first part is clearly moving our -- all of our production and production environment and delivery to the cloud, starting with Index and Analytics and then subsequently going to other product lines.

So that's going to be -- that's definitely cost-neutral to cost savings.

With the caveat, though -- and I'm glad you're asking that question, with the caveat that over the next 2 to 3 years, there will be a switch from capital expenditures and amortization to operating expenses because, obviously, we'll be paying Microsoft, what will be for us, operating expenses and we will not be investing in our server data centers and all the technology associated with that, right?

So that's cost-neutral to cost savings.

The second part is -- of the Microsoft is their ability to help us build new products such as client-facing technology, as an example, in order to drive more volume and more production into our processes.

And in addition to that, obviously, the use of newer technologies to capture data like AI and natural language processing and machine learning to capture data for models for data capture for ESG, for example, and for production quality in our Index factor.

And the third part is clearly the intent to be able to work together on an ESG platform.

So the second and third part, will this be net cost then for you guys?

[I hope it turns into growth...]

Well, the second and the third will have their own business plans with them.

But obviously, the revenue associated with that will need to surpass quite a lot the expenses.

It will be subjected to the, what we call the Triple-Crown investment criteria that we have inside MSCI, which is very high risk-adjusted returns; secondly, short paybacks; and then three, in areas of our business that have high multiples.

Got you.

I appreciate it.

And then just circling back to that $140 million of investments that you guys highlighted, how does that compare, I guess, to the prior year?

And what would have been this year, if not for all the events in the first quarter that carry on today with COVID?

It's about 15% higher than last year, and it's exactly the same dollar amount as we had at the beginning of the year.

What did change was some minor adjustments in the focus.

We de-emphasized certain products in the second quarter in certain areas in order to put the money in other areas that were more relevant given COVID and could give us a higher return and a faster payback.

Our next question comes from Alex Kramm with UBS.

Sorry to drag it out.

One quick follow-up, but it's multipart.

On the Hong Kong Exchange relationship, a couple of things.

One, I know I think you're excited about that partnership in Asia and, obviously, gateway to China and all that stuff.

But is it fair to assume that the economics are also better than with your prior partner in the region?

And then secondarily, anything that's already in the run rate for -- at the end of the quarter from that relationship?

And then lastly, is it purely volume-driven?

Or how big is any potential component of kind of, I guess, regular ongoing fees that are not volume-driven?

The -- that's definitely much better economics, for sure.

Secondly, none of it has yet hit the run rate and the P&L.

They'll start this current quarter.

And then three, it's mostly volume-driven with some minimum fees in case the volume goes through certain thresholds.

And in addition to that, obviously, it's not only the 37 futures and options contract, but obviously, the desire to launch more, particularly the ability at some point to launch MSCI China A futures and options in Hong Kong.

Our next question comes from Chris Shutler with William Blair.

Just one follow-up.

Henry, you mentioned working with Microsoft on an ESG platform.

Just curious what you envision that could eventually look like down the road?

Well, it's too early to tell.

And obviously, it's still early in our discussions.

But the -- we both recognize and are very keen on understanding, not only ESG but climate change, and how do we connect basically providers of capitals and users of capital into a platform that they can both use to understand the data that can be supplied by companies and be used by investors and the models and the ratings and all of that.

So -- but again, it's early days, so I don't want to give the impression that any of this is cooked or anything like that.

And we'll be reporting more as the discussions go on, but there is a very strong intent on both sides to try to work something out.

I'm not showing any further questions at this time.

I would now like to turn the call back over to Henry Fernandez for any closing remarks.

Henry, just a second, we wanted to do a few housekeeping matters before we ended the call.

A number of you had asked some questions about the below-the-line items.

So just before we close, we wanted to note that interest expense was slightly higher in our second quarter by $2.2 million for the duplicate costs of our old 2025 notes and our new 2031 notes for 30 days while we waited out the redemption period.

And we have maintained interest expense guidance for the rest of the year.

On interest income, we just like everybody to take a look at the fact that in a low interest rate environment, we're earning less on our cash balances than we had before.

That's -- right now, per quarter, we're earning about $1 million per year, maybe a bit less.

And in the previous quarters, that's been a bit higher.

So everyone should take a look at interest expense and interest income.

The other questions we got were on the tax rate.

And our 17.3% tax rate for the quarter was largely due to that loss on the debt extinguishment, which you can see in Note 10 of our financials.

Secondly, we had a higher income tax benefit related to some equity awards, which vested.

And third, we had a favorable mix of earnings.

So everybody can take a look at that.

Also, I wanted to call everyone's attention to our increased dividend of $0.68, it has now been increased.

And we'd just like to make sure that everyone models that correctly going forward to the $0.78, which was set yesterday.

So with that, I think we'll turn it back over to Henry.

So once again, thank you for joining us today and for your continued interest in MSCI.

A lot of great questions that you had for us, and I hope we're able to answer them as best as we can.

And obviously, don't hesitate to reach out to us if we have -- you have other questions or comments about what we could be doing better.

I hope we all stay safe, and have a great rest of the summer.

And we look forward to updating you for our third quarter earnings call in October.

Operator, this concludes our call today.

Thank you.

Ladies and gentlemen, this concludes today's conference call.

Thank you for participating.

You may now disconnect.