Can MSCI drag private markets out of the shadows?


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Henry Fernandez was once a counter-revolutionary. The man who over three decades has built MSCI, a provider of stockmarket indices, into a standard bearer of financial globalisation, started his career as a Nicaraguan diplomat in the government of Anastasio Somoza, a right-wing dictator. While some of his friends flocked to the left-wing Sandinistas ahead of the revolution that toppled Somoza in 1979, he took a look at socialism in eastern Europe and decided it was doomed to fail. Instead, he embraced free-market capitalism and moved to Wall Street.

There he encountered a different revolutionary movement that he has championed ever since: the forward march of capital markets. Starting in the Reagan era, he has played a role in several of the upheavals that have swept the world of finance, from securitisation in the 1980s and the growth of emerging-market investing in the 1990s, to the rise of index tracking and exchange-traded funds (ETFs) this century. He retains an idealistic streak. While many former advocates of environmental, social and governance investing have shied away from the climate-related fad of the past half-decade, he remains a true ESG believer.

He is now betting that MSCI’s indices can penetrate the opaque world of private finance—the $12trn-plus of assets held in private equity, credit, venture capital, real estate and infrastructure. These are some of the hottest segments of the capital markets. But they are restricted to institutions and well-heeled investors. In these secretive markets asset managers are loth to encourage more transparency and liquidity lest their fees suffer as a result. Yet technology may be moving in Mr Fernandez’s favour.

MSCI, which was spun off by Morgan Stanley, an investment bank, in 2007 and has a market capitalisation of $45bn, has two main revenue streams from indexing. The first is benchmarking. It has more than 280,000 equity indices around the world that tell investors what is going on in the public markets, and provide a measuring stick against which to judge fund managers’ performance. If a fund puts all its money into small-cap Japanese stocks, for instance, and MSCI’s medium- and large-cap Japanese equity indices do better, it underperforms. Almost $15trn of assets are benchmarked in such a way globally.

The second revenue stream is enabling investment managers to create financial products, such as ETFs, based on its indices. Almost $1.5trn of ETF assets are linked to MSCI’s indices, a nearly five-fold increase in a decade. BlackRock, the world’s largest asset manager, is the biggest client. Its boss, Larry Fink, and Mr Fernandez have been kindred spirits for decades.

MSCI’s first foray into the private realm is via benchmark indices. Since 2021 it has spent almost $2bn buying two data-gathering firms that create indices for private assets, from real estate and infrastructure to private debt. As Mr Fernandez explains, such indices enable a property investor to decide the relative merits of putting money into, for example, offices (which crashed during the pandemic) versus data centres (which soared). Gathering such information is tricky because many of the transactions are not publicly disclosed. MSCI creates indices by sourcing data from investors in private funds, who in turn receive records of those funds’ quarterly performance, including valuations of the underlying assets, from the asset managers. Its most recent acquisition, for instance, gives it data from about 13,000 private funds, representing $15trn in cumulative investments.

Could these benchmarks eventually form the basis for indices used by ETFs to bring private markets to the masses? It seems hard to imagine. Private assets do not trade with anything like the frequency of listed assets. They also lack the liquidity necessary for passive funds whose investors may want to redeem their money at short notice.

And yet Mr Fernandez believes that some parts of this opaque hinterland, such as private loans, are more liquid than others. “My bet is that over time there will be the development of a secondary market for private credit,” he says. To explain why, he goes back to his days as a young trader at Morgan Stanley during the “Liar’s Poker” era of the 1980s. The market for mortgage loans was fledgling and illiquid until the thrifts that made home loans came under pressure to sell them. Wall Street firms like Salomon Brothers and First Boston (where Mr Fink headed the mortgage desk) scooped them up, turned them into mortgage-backed securities and sold them to investors, creating a highly liquid secondary market. Similarly, banks that underwrite loans today face regulatory pressure to limit the size of their balance-sheets, so they sell some of the loans to firms with private-credit arms, such as Apollo and Blackstone. Mr Fernandez thinks that, as with the mortgage market, this trade could lead to a secondary market that would, eventually, have enough liquidity for index funds.

A big breakthrough will require advances in technology. For that, Mr Fernandez has his eye on his veteran comrade-in-arms, Mr Fink. This month BlackRock launched its first bitcoin ETF, and Mr Fink, who seldom keeps his cards close to his chest, hinted that this may be the start of a prolonged foray into the cryptoverse that could eventually encompass private assets. “If we could ETF a bitcoin, imagine what we could do with all financial instruments,” he told Bloomberg TV. “Everything is going to be ETFed.”

ETFs or WTF?

Mr Fernandez notes that Mr Fink has become an advocate of “tokenisation”—the idea that financial assets and their owners can be registered on a blockchain-like ledger, which could make it easier to trade property and other private assets. It is an idea in its infancy. Some people think it is barmy. The MSCI boss confesses that for the time being he himself does not fully understand it. But in contrast to the Sandinistas, who have betrayed everything they once fought for, his revolutionary zeal remains as strong as ever.

Read more from Schumpeter, our columnist on global business:
Why BlackRock is betting billions on infrastructure (Jan 18th)
AI can transform education for the better (Jan 11th)
Meet the shrewdest operators in today’s oil markets (Jan 3rd)

Also: If you want to write directly to Schumpeter, email him at [email protected]. And here is an explanation of how the Schumpeter column got its name.

Correction (January 28th 2024): This article was updated to better explain MSCI’s lines of business.

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