MSCI Inc. (MSCI) Q1 2023 Earnings Call

MSCI Inc. (NYSE:MSCI) Q1 2023 Earnings Conference Call April 25, 2023 11:00 AM ET

Company Participants

Jeremy Ulan - Head, Investor Relations and Treasurer

Henry Fernandez - Chairman and Chief Executive Officer

Baer Pettit - President and Chief Operating Officer

Andy Wiechmann - Chief Financial Officer

Conference Call Participants

Manav Patnaik - Barclays

Toni Kaplan - Morgan Stanley

Alex Kramm - UBS

Ashish Sabadra - RBC Capital Markets

Alexander Hess - JPMorgan

Owen Lau - Oppenheimer

George Tong - Goldman Sachs

Faiza Alwy - Deutsche Bank

Craig Huber - Huber Research Partners

Russell Quelch - Redburn Partners

Greg Simpson - BNP Paribas

Operator

Good day, ladies and gentlemen and welcome to the MSCI First Quarter 2023 Earnings Conference Call. As a reminder, this call is being recorded. [Operator Instructions] I would now like to turn the call over to Jeremy Ulan, Head of Investor Relations and Treasurer. You may begin.

Jeremy Ulan

Thank you, operator. Good day, and welcome to the MSCI first quarter 2023 earnings conference call. Earlier this morning, we issued a press release announcing our results for the first quarter 2023. This press release, along with an earnings presentation we will reference on this call as well as a brief quarterly 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, 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 will 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 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 revenues. We will also discuss organic 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 Andy Wiechmann, our Chief Financial Officer. Finally, I would like to point out that members of the media may be on the call this morning in a listen-only mode.

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

Henry Fernandez

Thank you, Jeremy. Welcome, everyone, and thank you for joining us today. MSCI delivered solid first quarter results in a challenging external environment, confirming the underlying strength of our franchise and our proactive financial management. We have not been immune to the market turmoil, but our resilience continues to stand out as seen in the headline numbers from the quarter, which include adjusted EPS growth of over 5%, organic subscription run rate growth of 12% and a retention rate of over 95%. On a segment level, we posted our 37th consecutive quarter of double-digit run-rate growth in index recurring subscriptions.

We also maintain our momentum in equity portfolio analytics, achieving run rate growth of over 10%. Meanwhile, climate continued to drive a wide range of growth opportunities, including with many emerging client segments, such as banks, wealth managers and insurance companies. MSCI delivered 68% climate run rate growth across our product lines and a climate retention rate of over 96%. The difficult environment has certainly affected buying behavior of our clients. In some areas, client budgets have tightened and sales cycles have lengthened, especially for larger purchases. ESG sales have also been affected by regulatory uncertainty in Europe and by a slowdown among wealth managers and retail investors in the United States, although institutional investor demand remains healthy and steady.

As we have noted in recent quarters, our AUM-linked revenue tends to be an early mover in market cycles, while our subscription revenue tends to see a lagging effect. Still, our client engagement levels remains very healthy, and we continue to find a steady demand for our products and services. Even in tough environment, MSCI’s unique competitive advantages endure. Clients need our data, models, analytics and research to navigate a rapidly changing investment landscape.

With that in mind, we continue prioritizing core investments in areas we believe we can fuel growth while maintaining very rigorous overall expense discipline. We also recognize the periods of turmoil can spur opportunistic M&A at more attractive valuations than we have seen in prior years, especially as this market cycle persists. We’re actively exploring potential bolt-on acquisitions that could accelerate our strategy.

Looking ahead, a key driver of that strategy will be the network effects produced by our One MSCI ecosystem. Our content and IP across product lines are already highly interoperable throughout the investment process. For example, clients can use MSCI tools to design an index-based portfolio, implement ESG or climate overlays on that portfolio and then run analytics on it. All companies at times face short-term wins, yet we continue to see powerful secular tailwinds for MSCI. This is true across product lines, asset classes and client segments. In a bull market, a rising tide can lift all boats. In a bear market, companies like MSCI differentiate themselves. MSCI remains confident that we can use this opportunity, this market cycle to strengthen our client relationships and/or increase our competitive advantages.

With that, let me turn the call over to Baer.

Baer Pettit

Thank you, Henry, and greetings, everyone. My comments today will focus on our business results this quarter, what we’re seeing and hearing from clients and how we are continuing to deliver on our dual commitment to our shareholders, namely the execution of our long-term growth agenda to capture more of our addressable markets while maintaining the profitability of the company.

We finished March with $1.84 billion of recurring subscription run-rate with an organic growth rate of 12% after closing more than $56 million of new recurring subscription sales during the quarter. It has been a slower environment for closing new sales as you can see from the year-over-year comparisons in our operating metrics, as we continue to see tighter client budgets and longer sales cycles.

While we cannot control the macro environment, we maintain our conviction in the mission-critical nature of MSCI’s data models, research and tools. Our sales pipeline and depth of client engagement across products and regions remain steady, and we have some promising larger deals that the teams are working hard to close in the second quarter.

Retention rates across the firm are holding up well in the tough environment with both index and ESG and climate reporting over 96% retention and 94% and 92% retention in Analytics and Private Assets, respectively. This is a reflection of the investments we’ve been making not only in our products but also in our client servicing capabilities.

I’ll now review a few additional highlights across product lines. In index, we drove 12% organic recurring subscription run rate growth with broad-based strength in both our most well established and emerging client segments and product lines. For example, in market cap-weighted index modules, our subscription run rate is now almost $600 million, and it grew 11% during the quarter. Investors are still turning to our market cap indexes to understand their global investment opportunity set across sectors, styles, sizes and geographies to implement rules-based strategies. They are also using our indexes to implement customized strategies and to express an investment thesis.

Our custom and specialized index modules are now $108 million of our subscription run rate and grew 13% during the quarter. Our index subscription run rate with asset managers expanded by over 10% this quarter including from areas where we have existing strength such as our core market cap index modules. Our subscription run rate with wealth managers has expanded by 23% year-over-year, supported by the licensing of our custom indexes for model portfolios and direct indexing use cases.

In Analytics, we drove 6% subscription run rate growth, excluding FX. New recurring subscription sales were almost $14 million during the quarter, roughly level with our performance in the same period last year. The current environment emphasizes the mission-critical nature of our analytics capabilities for institutional investors, and we’re able to close several new strategic sales for both our equity risk models and enterprise risk and performance tools.

Specifically, in equity portfolio management, we closed nearly $6 million of new recurring sales driven by equity risk model sales to hedge funds who use our models and tools to actively position their portfolios to benefit from volatility and market dislocation while also managing downside risk. During the recent period of market instability, our clients relied heavily on our analytics, models, research and tools, significantly increasing their usage on our platforms, helping them to better understand potential risks and associated exposures within their portfolios.

Stress testing, factor performance, liquidity risk and counterparty risk all remain in the spotlight as clients try to assess and manage their counterparty and market-risk exposure according to potential swings in market sentiment. Across all product lines, our ESG and climate run rate is now $453 million, which grew 20% year-over-year. Our firm-wide climate run rate is now $84 million, which grew 68% and continues to be one of the most attractive growth engines for us. We continue to launch new tools for our clients to better equip them to understand and manage climate risks and opportunities in the context of their investment portfolios.

In the past quarter, we have introduced biodiversity screens and insights as well as multi-horizon climate probability of default. Additionally, to keep pace with the growing number of public and private assets our clients are invested in, we expanded both our asset location database and the coverage universe of our implied temperature rise network which helps financial institutions incorporation set and meet climate targets. We believe our continued investments will help clients effectively navigate the evolving regulatory requirements impacting them, which will be a long-term catalyst for growth.

However, in the short term, some clients are slowing down buying decisions in order to better understand new proposed or potential regulations. As we have previously stated, we are preserving investment capacity to secure new growth. Our intention is to preserve as much investment as possible in key areas aligned with client demand and where we believe we can deliver attractive returns, such as climate, ESG, client design indexes, fixed income and the ongoing modernization of the client experience.

In parallel, we are equally focused on creating greater efficiencies across the company to allow us to fund these important investments. As I stated at the outset, we will continue to deliver on our dual commitment to shareholders, which means executing on our long-term growth agenda while maintaining the profitability of the company.

With that, I will turn the call over to Andy. Andy?

Andy Wiechmann

Thanks, Baer and hi everyone. The financial results in the quarter showcase the attractiveness of our financial model and the effectiveness of our actions. Subscription revenue, which is 75% of total revenue, remained steady with 13% organic growth while we continue to feel the pressure from year-over-year declines in AUM-related revenue with ABF revenue down 8%.

While the first quarter tends to be seasonally lower for new sales. Our results in the quarter were softer than last year, reflecting several factors. Relative to a year ago, we saw some lengthening of sales cycles and fewer larger ticket deals. These dynamics were particularly pronounced in the Americas and within our ESG and climate segment. In ESG and climate, the impact of macro pressures and constrained client budgets had a more pronounced impact where the details of pending or recently released regulations have not been fully clarified or interpreted and where there is likely a higher level of more discretionary purchases in certain use cases.

Additionally, in some areas of the firm, we saw a modest decline in retention, most notably coming from smaller hedge funds, broker dealers and real estate brokers and developers, although importantly, firm-wide retention rates remain fairly strong overall and in line with historical averages. While the longer term demand and pipeline remain steady, we expect some of these cyclical ESG dynamics to persist in the short-term. But overall, we continue to operate from a position of strength with strong momentum and healthy client engagement across our subscription base.

In index, subscription run rate growth was 12% in the quarter. Client demand for active and passive index strategies remained healthy. We again saw notable strength within our market cap modules as clients continue to integrate indexes more heavily into their investment processes, and we continue to benefit from a growing trading ecosystem. Since the end of December, AUM balances and MSCI-linked ETFs have rebounded by over $82 billion, including over $7 billion of cash inflows, which helped asset-based fees improved by 6% since year-end. We saw strong flows into both developed markets outside the U.S. and emerging market funds, both areas where ETFs based on MSCI indexes had strong market share capture.

Recently, one of our clients completed the largest ETF launch in history based on AUM, which is linked to MSCI’s Climate Action indexes. Traded volumes of listed futures and options linked to MSCI indexes remained slightly elevated but saw some normalization relative to the high market volatility environment last year. Within those cyclical dynamics, we continue to see the secular build of volumes resulting from the growing liquidity and trading ecosystem around financial products linked to our indexes, and the growing volumes of listed futures and options have helped drive growth in the broader index derivatives franchise.

We continue to see healthy client appetite for structured products and OTC derivatives linked to MSCI indexes as well as strong demand from trading firms and hedge funds for our index data. These areas help to support both recurring and onetime sales volumes. In Analytics, subscription run rate growth was 6%, excluding FX. We continue to see strong demand from the buy side for our equity risk models and our broader equity portfolio management tools.

Despite some of the previously mentioned pressures, the mission-critical nature of our analytics tools in these environments continues to provide a path of steady growth. In our ESG and climate segment, we saw overall organic subscription run rate growth of 30% with growth in EMEA at 34%, while growth in the Americas slowed to 24%. Coinciding with the slowdown in new ESG fund launches in the region and some slowdown in client buying decisions related to the previously mentioned factors.

In climate, we continue to see good momentum and very engaging discussions across client segments, although some of the factors impacting ESG sales did, to a smaller degree, also impact climate sales. Our climate subscription run rate growth across all products was 68%, which was roughly the same as the Climate ABF growth rate. In real assets, we continued to deliver double-digit organic subscription run rate growth of 10%. We see strong engagement from our clients as they look for insights into the highly dynamic market, including around climate and income risk, although we did see some pickup in cancels from smaller clients in the quarter.

I’ll now go over the puts and takes of our 5% growth in adjusted EPS in the first quarter. While asset-based fees were lower than last year, growth in subscription revenues was a significant driver of the $0.16 adjusted EPS expansion year-on-year. The lower share count drove $0.07 of the year-over-year increase, benefiting from the significant level of opportunistic share repurchases we executed last year.

I would note that our Q1 adjusted EBITDA expenses of $247 million included about $22 million of seasonally higher compensation and benefits-related expenses that we had anticipated and indicated to you previously, although we did have some comp-related accruals and non-comp items that were slightly more favorable than expected. We remain well capitalized and ended March with a cash balance of nearly $1.1 billion.

On client collections, we continue to see slightly longer payment cycles consistent with our prior comments due in part, we believe, to the opportunity cost of a high-rate environment. There were no share repurchases during the quarter, although we continue to be poised for and actively focused on attractive repurchase and potentially compelling bolt-on M&A opportunities. We continue to believe this environment could result in some repricing and/or unlocking of previously unavailable acquisition opportunities.

Lastly, I would like to turn to our 2023 guidance. Our guidance ranges across all categories remain unchanged. It is important to note that we have based our guidance on the assumption that ETF AUM balances declined slightly from current levels in the second quarter and gradually rebound in the second half of the year. While the environment may result in some caution from clients in the next quarter or two, we have the financial model and the proactive management levers to drive investment in the very compelling long-term growth opportunities while delivering very attractive financial performance. We remain encouraged by the strong client engagement across numerous growth opportunities, and we continue to be closely aligned with the long-term trends transforming the investment industry. We look forward to keeping you all posted on our progress.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Manav Patnaik with Barclays. Please go ahead.

Manav Patnaik

Thank you. Good morning. I just wanted to just talk about the ESG slowdown specifically, I mean, is the comments around the regulatory delay, is that just people waiting. I just want to understand why that would impact whether they needed the data that you guys have or not. And then just hoping you could just break out the strong growth rates in ESG, like how much of that is new sales versus cross-selling or upselling and pricing, just to help understand which part of that dynamic is being impacted the most?

Henry Fernandez

Manav, thank you for the question. First of all, let me just level set a little bit. As Andy indicated, ESG and climate, the – we had a 30% run rate growth in the segment per se with 34% in EMEA, over 20-plus percent in the Americas. And we had a 21% run rate growth firm-wide in ESG and climate despite the lower AUM-linked revenues that we have had given the decline in equity values around the world. So in any environment, these are not too shabby numbers to begin with, they’re definitely lower than the recent past, but not bad at all. So we’re very pleased about that.

The second point that I will make before I go directly to your answer, Manav, is that we’re very excited about a number of new products that we’re launching in ESG and climate. First of all, we are continuing our ESG rating coverage expansion into more equities and more fixed income and other private assets that will bode well for additional sales. We’re very excited about the uptake on the total portfolio, carbon footprinting service that we’re offering, which includes public and private assets and includes corporate bonds, for example, for banks. We have launched a European bank regulatory product in which – for climate risk. So that’s important. We’re launching a biodiversity set of data and products with a partnership with the firm. On climate risk, we’re very excited about the Climate Lab Enterprise. In addition to the climate probability of default, we believe that climate risk will be a major driver of risk analytics in the future and the like. So now, there is a lot that we can say about that.

So now in direct answer to your question on the slowdown, there are two components – there are two major regions where our ESG and climate sales are happening is clearly the Americas and EMEA. And the Americas, especially in the U.S., we have seen a meaningful slowdown in sales due to some of the geopolitical issues and political involved discussions that are going on about ESG. And the institutions that we deal with, they are all continuing to subscribe to the product line and they are continuing to integrate ESG and climate into their portfolios. They are trying to stay low key so that they don’t get in the crossfire of the political system. And what we have seen is definitely a slowdown in retail demand, wealth managers, mutual fund launches and the like because a lot of the asset managers, again, are trying to assess the whole political landscape and being cautious not to get caught in the middle of that.

We believe that, that’s going to persist maybe for a year or more, given the elections coming up. But at some point, it’s going to have to revive because ESG and climate are an integral part of the investment universe. In EMEA, our sales have held up pretty steady from prior quarters, no meaningful reduction in sales. But obviously, in EMEA, the regulators have come up with a new system as to what is an ESG fund and what is not. So similarly to what I was saying in the Americas, the institutional demand remains pretty steady and very robust. The retail demand is going through a little bit of an adjustment as to what is an article 9 fund, what is an article 8 fund. So our clients are sort of – sorting out how their product lines up to a lot of that. And we believe that once they finish that process, they are going to start launching ESG and climate funds because the fundamental demand in EMEA continues to be very strong.

So in a nutshell, we continue very excited about this segment. The growth has slowed down a little bit in addition to because of the cautionary budget that exists in the world plus these other things, the political situation in the U.S. and the regulatory situation in EMEA. But the fundamental demand is there. This is a product that is here to stay especially the – in all aspects, actually, the integration and the impact investing and all of that. And it’s just a question of when we begin to see a return to higher growth rates.

Andy Wiechmann

And Manav, just very quickly on the composition of new recurring sales to your question, the strong majority of new recurring sales continue to come from the new clients and new services or upselling our existing clients. I’d say, the breakdown between those is roughly even. So roughly even contribution from new clients and new services. I would highlight price is contributing a slightly higher percentage than what we’ve seen in the past to new sales?

Manav Patnaik

Okay. That’s very helpful. Thank you. Just on the M&A, I think you guys mentioned it a few times in terms of the valuations coming down and exploring bolt-ons. I was hoping you could just elaborate a bit more on that. It sounds like it would be a series of small to midsize tuck-ins and in the obvious areas of ESG and data and so forth? Or just hoping that you could give a little bit more color there.

Henry Fernandez

So as we said, Manav, these are all smaller bolt-on acquisitions. There is nothing sizable or transformational that we can see on the horizon that obviously can change at any point, but we don’t see that happening. So we have been – as you have seen, as we’ve been relatively muted in our acquisition past in the last few years because we’re very disciplined buyers. Even if an asset is very strategic, it has to have financial underpinning stores. It has to make sense financially. We saw a lot of our competitors bidding up assets to levels that we would not want to participate in, in the past. So we’re waiting to see if this environment brings down those valuations that make a lot more sense and obviously only in the strategic areas that we’re interested in. So that’s why we wanted to emphasize that and especially in the context of the lack of repurchases because we don’t have a huge amount of cash, and we have wanted to preserve cash for these opportunities when and if they come.

Manav Patnaik

Okay, fair enough. Thank you.

Operator

The next question comes from Toni Kaplan with Morgan Stanley. Please go ahead.

Toni Kaplan

Thanks so much. Just wanted to follow-up on ESG questions. I guess I definitely understand what you just mentioned on political environment and retail, etcetera. I guess do you see ESG getting worse before it gets better? Or is – should we just expect sort of a maybe modest environment for the next year?

Henry Fernandez

Thank you for that, Toni. First of all, let me just reiterate that our ESG franchise is very diversified – ESG and climate franchise is very diversified across regions, across types of customers that – what we call client segments, whether it’s an institution – an institutional investor manager managing institution of money versus a manager managing individual or wealth money across banks and across, as I said, regions of the world, and use cases. So this is very varied and the like. So what I want to make sure we all recognize is that the U.S. marketplace is a clearly important one. But within the U.S. marketplace, you’ve got to break it down into what is going on with the – with managers who are managing retail money versus people who are managing institutional money versus the banks who have a different driver versus the hedge funds and all of that. So therefore, it’s a lot of different areas that we need to look at.

My sense – our sense at MSCI is that the area of the market that it is asset managers managing mutual fund money or ETF money or wealth money is going to stay subdued and for a couple of reasons. One, the client segment, half of them are blue and half of them are red and some of them are going to have different views as to what this product line should be. Secondly, a lot of asset managers are trying to stay below the radar screen of a lot of these political wins. They don’t want to be attacked, so they don’t want to be making a lot of fanfare about new products, they are launches – launching, etcetera. So in the U.S., it’s going to stay a little bit subdued on that segment of the market, but it will not be on the institutional market, and it will not be on climate for banks, for example, climate risk for banks and others. In EMEA, I think this process of reclassifying funds and reordering things, it’s going to – still may take a few months, a few quarters, and then the demand will pick up again in the context, obviously, of a total operating environment. And when we’re beginning to see a lot of traction in Asia in all client segments and that is virgin territory for us.

Toni Kaplan

Great. Very helpful. I wanted to also ask just in this sort of current environment, how you’re thinking about investment in ESG products. So I know long-term view as the trends are positive but I guess in maybe near-term, do you shift your investment towards other areas or have you been shifting your investment towards other areas just in light of what’s been going on? Thanks.

Baer Pettit

Hi, Toni, Baer here. So look, maybe just using a slightly different tone, I can’t control myself. Look, ESG and climate still grew 30% in this quarter, right? That’s a very attractive growth rate, and for sure, if we can sustain that sort of growth rate on the run rate we have, that remains a very significant opportunity and adding the – that amount in dollars in run rate every quarter, for sure, will continue to require a lot of investment. And as Henry has pointed out, we have continuous demand across a variety of client segments, geographies, etcetera. So there certainly isn’t anything between this quarter and the last which changes our view that this is a structurally important opportunity, right? So we have to balance it with the environment. And Henry alluded to certain strains, if you want to call it that. But certainly, from our perspective, this is a growth opportunity. It is structurally so and we have a lot of client demand for continued data and improvements in the product line.

Henry Fernandez

Let me just add something else here, and that is ESG and climate is one category that we use. Within that category, you also have to look at the ESG component, which obviously has climate – a part of that is climate. So you have to look at the climate tools themselves on a stand-alone basis, and we’ve been able to – we began to create more disclosures about that for all of you. So on the climate side, the run rate grew 68% to about $84 million, $85 million in run-rate. We believe that in the next few years and probably the next 5 to 10 years, climate is going to be the biggest opportunity that all of us are going to be faced with the whole world needs to figure out – the whole world of the capital markets, the investment industry and the finance and insurance industry will need to deal with climate risk in their portfolio, decarbonization of their portfolios and the like. So we continue to make a steady investment in that area because we want to be one of the undisputed leaders on climate and the consequent growth that we can see in value creation.

Toni Kaplan

Makes sense. Thank you.

Operator

The next question comes from Alex Kramm with UBS. Please go ahead.

Alex Kramm

Yes. Hey, good morning, everyone. Just wanted to talk about the sales environment in particular, what happened in the first quarter. Clearly, the second half of March got very volatile with some of the bank issues. So knowing salespeople, I know sometimes those sales can happen right at the end of the quarter. So just wondering if that was a big headwind at the time, if you actually think some of the 1Q opportunities got pushed into the second quarter or if somewhat you just saw at the end of the first quarter, actually, is just a look at what may be to come and things actually get worse from here near-term on the sales side.

Henry Fernandez

Definitely, Alex, you’re absolutely right. The – a lot of stress in the system happens in the last 2 weeks of a quarter in terms of clients and making budgetary decisions, and we’re trying to close on sales. And the banking scare and the banking crisis took place around that time. There probably was some smaller impact in delaying some sales at that time, but it wasn’t anything that we spend a lot of time on. So that tells you that within sort of that as pretty serious to the closing of the sales in the quarter. And the banking crisis per se, it doesn’t have a huge direct effect on us because it has been concentrated in some of the smaller banks, obviously, with the exception of Credit Suisse, which was already in difficulties. The bigger banks, which are our clients are extremely well capitalized, they are extremely regulated, so we’re not as concerned about them. But I think the overall banking crisis does add to the stress in the overall financial system. It adds to uncertainty. It will add to cautiousness and a little bit of risk aversion. So that’s likely to add one more variable to the environment that we have depicted here. We remain pretty – with respect to our pipeline and sales, it remains pretty solid. It remains pretty healthy with a caveat that the larger deals have slowed down what we call the big-ticket items have slowed down. Secondly, the sales cycles are longer and maybe there is a little bit of pickup in cancellations. But we’re not looking into the near future and thinking that we have a big problem coming our way.

Alex Kramm

Okay. Great. And then secondarily, you made some comments about still very focused on profitability and growing profitability. I think over the last few months, I’ve heard you speak a little bit more when it comes to profitability in terms of EPS, earnings per share, and not as much on margins or EBITDA margin. So just curious, when it comes to EBITDA margin, which a lot of us care about, are you still very committed when you talk about profitability on growing core margins? Or are you thinking more holistically? Or what’s your latest thinking about profitability?

Henry Fernandez

That’s a great question because, as you know, I’m a large shareholder in MSCI. So when I look at myself as a shareholder, at the end, what I care is about the long-term growth of the adjusted EPS. And that’s what’s going to – if we have very healthy growth of adjusted EPS over years and years, with healthy top line and healthy sort of EBITDA margins and the like, the market will reward us with good multiples and good valuation.

So we’re beginning to focus a lot more on that, but it’s not at the exclusion of clearly top line growth. It’s not at the exclusion of our EBITDA and our EBITDA margin. It’s just a little bit of a mixing of the variables. The problem in the past for us has been that we were so focused and so obsessed with EBITDA and EBITDA margin that at times when elected the EPS growth is not a big company, so I thought I was wrong because our shareholders that’s what they eat. They eat EPS growth. That’s what they value the company on the basis of that. Obviously, there are a lot of other things that make up that, but that’s a little bit of the – it’s not an exclusion. It’s just a pivoting of emphasis.

Alex Kramm

Thank you. Thanks for clarifying me.

Operator

The next question comes from Ashish Sabadra with RBC Capital Markets. Please go ahead.

Ashish Sabadra

Thanks for taking my question. Baer, in your prepared remarks, I believe you mentioned there are some promising larger deals that the teams are currently working on to close in the second quarter. I was wondering if you could just provide some more color on those deals, which are the uncertain end markets. Is it focused more on index analytics or ESG? Any color on those fronts? Thanks.

Baer Pettit

Sure. No, look, I think it’s the normal mix, Ashish. I don’t think that there is any particular color to it. There is some important stuff we have, for sure, in Analytics. We have some large ESG deals and index. So the point was more to make a broader observation and picking up from Henry’s observations that we haven’t seen a decline in our pipeline. We’ve got – we had a few things referencing the larger deals that had a slightly longer sales cycle than we thought, and again, referencing also Alex’s question. So it was more of a general observation just to say we’ve got some – we’ve got a healthy pipeline going into the next quarter. And we’re very focused on trying to close.

Ashish Sabadra

That’s very helpful color. And maybe just a quick follow-up. As we think about the sales slowdown on the subscription growth, obviously, subscription growth has been really robust 12% despite the macro challenges, but how should we think about some of these sales slowdown headwind on subscription growth. But on the other side, we also have ABF improving as the AUM fund flows improve. So any puts and takes on the top line as we think about going forward? Thanks.

Andy Wiechmann

Yes. Ashish – and Henry alluded to this in his prepared remarks. We have this nice balance in our top line, where the ABF revenue tends to lead a cycle and the subscription revenue tends to be impacted on a lagging basis. I don’t want to overemphasize that we might be seeing some lagging impacts on the subscription base right now, but there probably are some impacting it, although it’s important to underscore that our retention rates remain quite healthy, in line with historical averages here, particularly in index and analytics, and ESG is even 96% plus. And it is quite a diverse book of business.

And the two biggest pieces of it, index and analytics, are actually remaining quite strong here. And the outlook is okay on those fronts. And so in the short-term, there could continue to be some impacts on operating metrics, which impacts the subscription growth. But I’d say, overall, we’ve got quite a resilient franchise. And to your point about asset-based fees, to the extent the market starts to recover and has a sustained recovery, that just adds to some of the momentum we have in the business and the resilience we have in the business. I would underscore, as I mentioned in the guidance comments that we have a cautious outlook in the short-term. So our guidance is based on the assumption that ETF AUMs declined in the second quarter and then rebound gradually in the back half of the year. But any upside there is obviously beneficial to us and creates capacity for us to invest more.

Ashish Sabadra

Very helpful color. Thanks, Andy.

Operator

The next question comes from Alexander Hess with JPMorgan. Please go ahead.

Alexander Hess

Hi, good morning, all. I just want to touch again on the retention rate briefly, 95.2%. I believe that was up somewhat from 4Q. Can you comment maybe how much of that sequential quarter-on-quarter improvement was driven by any sort of improvements or changes in the client environment? Or was that just seasonal factors there?

Andy Wiechmann

Yes. I would say the seasonal aspects do play a meaningful role. Given that we have the largest portion of renewals taking place in the fourth quarter, retention rates tend to drop a bit there. So I wouldn’t read too much into the sequential dynamics. As I just mentioned, we are encouraged that the overall retentions are in line – overall retention rate is in line with historical averages. And so, we’ve just seen some pullback from the high levels we saw a year ago. But overall, they are in a pretty good position. And as Baer mentioned, really where we are seeing the pickup in cancels is in ESG and climate and real assets. And from a client standpoint, it’s really showing up with smaller clients and within areas like broker-dealers and banks, hedge funds, real estate agents and developers. So it’s kind of around the edges and some of the structural stuff and client events that we would typically see in these types of environments.

Alexander Hess

Thanks, Andy. And maybe as a follow-up, you briefly mentioned real assets. Just wanted to maybe get an update on anything that’s gone on there with the Burgiss group with RCA. We’re a couple of years out now from some pretty large spend on those areas. It would just be nice to get an update on traction in the market and anything else you can maybe provide us with on those businesses.

Baer Pettit

Sure, I’ll make a few comments. So first of all, if we look at the overwhelming run rate is in real estate, just clearly been a very challenging environment across the globe. In view of that, we were pretty pleased actually to have an 8% run rate growth or 10% ex FX. So for example, transaction volumes in the U.S., which is clearly critical for us in that part of the market have been down 70%. And some of our other important markets from like the UK have been hit very hard but we’ve had actually really decent retention rate there.

So I think allowing for the very challenging environment, we’re pretty happy with the results. And we will have to see – there is certainly sometimes a little bit of a lag from, let’s say, the REIT’s repricing to other private markets. We could still be in a choppy environment for real estate for some time. But in view of that, I think the resilience of our franchise is pretty strong and people need our data and analytics precisely to understand the performance and risk in these changing markets. So that’s that. And I think on Burgiss, we don’t really have anything to add from the last quarter. So I think that those are my summary comments, right.

Alexander Hess

Thanks, guys.

Operator

The next question comes from Owen Lau with Oppenheimer. Please go ahead.

Owen Lau

Yes. Thank you for taking my questions. So broadly speaking, how does the reopening of China and the comeback of some Chinese stocks impact AUM and the flow of MSCI-linked index in the Asia Pacific region? And then, maybe could you also please talk about or give us an update on the opportunity in the Asia Pacific region and how MSCI would approach these opportunities? Thank you.

Henry Fernandez

Thank you, Owen. The – clearly, the opening of China from loan protractive COVID lockdown is positive for our business in all of Asia, not only in China, but all of Asia because, as you know, China has a meaningful economic and additive impact in the balance of the countries in Asia. So that’s been very positive. Despite the fact that the lockdown, we don’t even see clients in Mainland China. I mean it was really, really draconic as you all know. We have been managing to grow our MSCI China. We have been able to grow the business both in Mainland China and on a run-rate growth basis, about 9%, 10% in this quarter compared to last year. So that’s a positive.

Now, we have to – so China itself, Mainland China is a very small, almost non-material run rate for us. The assets that are linked to – directly to MSCI China indices are not significant. Obviously, the big effect is the part of the emerging market index that is made up of China, and the recovery there is going to bode well for the overall emerging market index and the assets associated with that emerging market index, so that’s going to be a positive for us. So, that’s a little bit of the breakdown of the various components. So, we are very optimistic that the recovery in China, the asset, the equity values increasing in China and the opening up of the country will have overall positive effects for our business. But as I have said, it’s not a huge base, except with the – except for the part of MSCI China that is in the emerging market index.

Andy Wiechmann

And just to put a finer point on the ETF flows. We did see pretty healthy flows into international markets, both developed markets outside the U.S., but to Henry’s point, also into EM exposure. And those are two areas where we had nice market share capture. On the EM flows, we actually captured about 60% of new flows into emerging market ETF. And clearly, China is a big component of that.

Owen Lau

Got it. That’s very helpful. And then can I go back to the guidance for a little bit. And I think Andy, you mentioned that you assume that ETF would decline slightly in the second quarter and then rebound in the second half. But I remember previously, you mentioned that the market would decline in the first half of this year. I am just wondering is there any change in assumptions here? And then I think broadly speaking, what does it take for MSCI to kind of like dial up or dial down the free cash flow guidance for this year if, let’s say, the market stay at current level? Thank you.

Andy Wiechmann

Sure. I would say, overall we continue to have a cautious outlook in the near-term, which you can see by the ETF AUM assumption that’s underlying our guidance. Just to reiterate what you alluded to, we are assuming the markets’ decline from the current levels during the second quarter here and then rebound gradually in the second half of the year. Just to your question about what it would take for us to dial up or dial down, I would say it’s a constant calibration. It’s something we are actively focused on. Although the markets performed better during the first quarter than the assumption we had outlined in our original guidance at the beginning of the year, we still continue to have a cautious outlook in the near-term. And so, we are being cautious on expenses and the pace of hiring where we are being a little bit more measured. And we continue to be disciplined on the non-comp expense front to ensure we are able to invest in those critical growth areas and attractive long-term opportunities. We do have, I would say, further levers on the downside if we need to, and we can further slow or even stop headcount growth, and we can further tighten non-comp on the downside. But importantly, to your question, if we do see a sustained improvement in the markets, we are ready to accelerate investment and spend. And so, it would be really a calibration and a determination that we see that sustained momentum in the markets and confidence that we are recovering here. And if we see that, then I think you could see us dial up the pace of spend. And I don’t want to comment specifically on what that would mean for free cash flow. There is a lot of puts and takes there, but I would say all the guidance is a reflection of the outlook that we have, and we have currently got a cautious outlook.

Owen Lau

Got it. Thank you very much.

Operator

The next question comes from George Tong with Goldman Sachs. Please go ahead.

George Tong

Hi. Thanks. Good morning. I wanted to drill down further into the selling environment. You talked about being tighter client budgets, longer sales cycles. Outside of ESG, can you elaborate on where in the business you are seeing the most impact from that and how client sentiment has trended exiting the quarter?

Andy Wiechmann

Yes, sure. So, listen, the way it manifests itself, and I am just underscoring points that we have made because I am trying to stick to what we are seeing here, which is fewer large ticket deals, lengthening of sales cycles and elevated cancels, particularly among smaller clients and particularly in just ESG and real estate. Those impacts are most pronounced in those two segments where I think there are some segment-specific factors. Henry outlined some of the factors impacting ESG, and Baer talked about some of the factors impacting real estate. I do want to underscore that index and analytics see some of those dynamics to a small degree, but are generally holding up okay. And there continue to be a number of large and key areas, not only in index and analytics, but also in ESG and real estate, where we continue to see strong momentum. And many of those are the core aspects of those parts of the business. Geographically, the dynamics were most notable in the Americas, but I would say that was heavily driven by the impact in ESG and climate. But overall, pipeline is steady, as Baer said, and we do expect some of these dynamics to continue in the short-term. But I think we see the indications that the engagement with clients on these big secular trends continues to be quite healthy.

George Tong

Got it. That’s helpful. And then you talked a little bit about the analytics business holding up relatively well. Organic revenue growth of 6% in the quarter, it is a bit below the long-term target of high-single digit growth. Do you expect the growth there to accelerate over the course of the year? Do you expect it to stay where it is? And what are some of the puts and takes of underlying trends you are seeing in the analytics business?

Baer Pettit

Yes. So, look, I don’t think there is a dramatic change. We had a few large deals that didn’t quite make it this quarter. We didn’t do quite as well as we would have liked in fixed income this quarter. But actually, we have got a really good pipeline there and that business is going from strength-to-strength and so it’s a little bit of a mixed bag. So, I don’t think we don’t see anything dramatic. We would like to do a little better than we did this quarter for sure. We have got a decent pipeline, including some of the larger deals that I alluded to in my earlier comments to Owen, I think it was. So, I think overall, we are working the pipeline. We would like to see the growth a bit higher than it is here, but we don’t expect anything dramatic from where we are right now.

George Tong

Got it. Very helpful. Thank you.

Operator

The next question comes from Faiza Alwy with Deutsche Bank. Please go ahead.

Faiza Alwy

Yes. Hi. Thank you. So Andy, I wanted to just put a final point on expenses and investments. You mentioned some favorability this quarter. And I know you have maintained your expense guide, but you have talked about being measured also and that there are further downside levers and upside levers. So curious, has anything changed over the last few months as it relates to your investment spending relative to the expenses that you are incurring and how you are viewing that for the rest of the year?

Andy Wiechmann

No, nothing too significantly. As I said, we did a roll forward of the ETF AUM assumptions that underlie our guidance at the beginning of the year to where we are now. Clearly, the markets performed a bit better in the first quarter than we had baked into the original guidance, but we continue to have this cautious outlook and assume that the markets will pull back a little bit here in the short-term and then rebound in the back half of the year. And so, I would say, the overall view on expenses and pace of spend is generally consistent with where we started the year. I would say we continue to have that degree of caution here, and we have moderated the pace of headcount growth, although you probably saw we continue to grow, and that’s in the key areas, the key growth areas for the firm.

Henry Fernandez

Let me just add something because we keep – we have referred a number of times to our outlook in terms of asset values, equity asset values. And I want all of you to understand that there is no magic. We don’t have significantly better insights than you have about what could happen to equity values in the foreseeable future. The emphasis on this is that we manage our expense base, is that we manage our investment plan. And therefore, when we say we are predicting the following, it’s in order to give you a sense of what is our mindset in order to manage our expenses and our investment plan. We want to be in a position that if we get positively surprised that the equity values are higher than we thought they would be, we can rapidly do an upturn playbook and invest more. But what we don’t want to be is going into a difficult environment with a bloated expense base and having to radically alter our expenses and our investments and the like. So, that’s a little bit of the mindset of what we are trying to do here. But there is no – we don’t have any major insights that the market will go down in the second quarter or the third quarter. We just use this as a mechanism to manage our expense base.

Faiza Alwy

Understood. Thank you for that. And then just a follow-up on the climate side, you mentioned obviously slowing new sales on the ESG and climate segment, then you mentioned the political environment in the U.S. and some regulatory uncertainty in Europe. It sounded to me – my takeaway is that that’s more on the ESG side as opposed to the climate side. But curious if that’s the right takeaway and any further color you might have on that.

Henry Fernandez

Yes. So, that’s a good question. First of all, you also have to look at the ESG and climate sales in the context of an overall caution environment or cautious environment of spending by our clients all over the world because they are – they don’t know the direction of equity values or financial markets. They don’t know yet when interest rates are going to start peaking, what the level of potential slowdown or rotation may be etcetera, etcetera, right. So therefore, any product line will have to take into account that the overall spending of clients is more cautious now than it has been in the last 12 months or so. So, secondly, with respect to ESG and climate, yes, a lot of the – some of the political issues in the U.S. are referred to as ESG. But when you really hear the politicians, sometimes they are referring to social issues in ESG, and sometimes they are referring to oil and gas or climate risk issues and the likes of that. So, the caution about the U.S. market, even though you hear it as ESG alone, it varies. If you go to Florida, a lot of it is about social and the ESG. If you go to Texas, a lot of it is about the environmental part or the climate part of ESG. So, we think that the institutional demand will increase on climate in the U.S. and across the board, but the individual retail demand may be a little bit slower. In Europe, climate is – the climate tools are in demand all over the place because Europe, as we all know, is a leader in trying to figure out how to decarbonize their economies, how to increase renewable efforts. And they are pushing the asset managers to take climate into account. So, 68%, 70% growth rate on climate is not bad. It slowed down clearly from a year ago, but we are very, very optimistic about the prospects of climate tools in the world for us.

Faiza Alwy

Great. Thank you.

Operator

The next question is from Craig Huber with Huber Research Partners. Please go ahead.

Craig Huber

Great. Thank you. On the climate front, can you just tell us quickly, if you would, what data and what analytical tools, you guys think you have in climate that really sets you guys apart from your peers out there? And obviously, you talk about long-term. You think your climate run rate will eventually get larger than the rest of ESG. So, what really makes you stand out from a data standpoint and tools from climate?

Baer Pettit

Yes. So, I think there is a variety of things. And of course, we would be very happy to also take this offline because it’s a longer discussion. But fundamentally, it’s the breadth and depth. It’s what we cover in terms of climate – companies, excuse me and securities. It’s our modeling of climate, including some of our more sophisticated indicators like implied temperature change. And in physical risks, the competitive landscape is such that it’s a little checker depending on what part of the market you are in. But those are some of the highlights. But it’s obviously – it’s a large question, which we would be very happy to spend more time with you offline.

Andy Wiechmann

Yes. And Craig, if you don’t mind, I just want to underscore one point, which I think you know, but it is really an important differentiator for us. That be $4 million [ph] of climate run rate cuts across all product segments for us. And so the ability to offer solutions across almost every part of the investment process really differentiates us from other providers out there. So clearly, index is a big part of it, which I know you are aware, but our leadership in index is more generally. And our leadership in climate caused us to be a leader there. Our ability to provide climate risk insights across analytics where we have the clients’ portfolios, we are helping them with risk already really give us a leg up on anyone else trying to do climate risk at a portfolio or an enterprise level. And then in areas like private assets, just given our capabilities and unique data we have on that front gives us a real leg up. So, the total franchise that we have is a real competitive advantage that I want to make sure people don’t lose sight of.

Craig Huber

Thank you for that. My second question, you obviously kept your cost guidance unchanged here. Often, companies when they go into a much tougher – what they think is a tougher environment, will cut their cost base significantly. I am curious, given your added cautionary comments right now, you did not though cut cost outlook for the year. Was it – is the environment basically how you were thinking it was, say, three months when you put out your initial guidance because again, you did not trim your cost outlook?

Henry Fernandez

Okay. I think we are extremely comfortable with our cost base, our expense base, which we divided up into running the business expenses on what we call change the business expenses, which is the more pure investment plan. We have preserved in the last few quarters the vast majority of our investment plan. And we have done that by squeezing around the business expenses in a variety of ways to free up resources, okay. So, we are very, very comfortable. We believe we have scaled the expense base of the company to the operating environment, to the cautious operating environment that exists today, even with a lower operating environment that exists today. In the event that it dramatically moves down, we have a lot of levers that we can apply. But if anything, we believe that the probability of us triggering an upturn playbook is probably higher than downturn playbook, but we don’t know. I mean obviously, we have to see what happens in the next few quarters. So, we are extremely comfortable. The other thing to remind everyone is that MSCI is a very diversified client base – a diversified franchise. We tend to not focus on that. It’s diversified about client segments from asset owners, to asset managers to – from wealth managers and banks and insurance companies on our corporates and hedge funds and banks, the regions of the world. We are doing well in EMEA right now, relatively well in EMEA, to the Americas, to the Asia-Pacific region. The product lines and public assets, equity and now fixed income and private assets and ESG and climate has overlaid to all of what we do. We have a lot of performance tools. We have a lot of risk tools. We have different forms of pricing whether it’s subscription, whether it’s AUM, whether it’s transaction and then volumes like in futures and options. We have a very diversified employee base. 65% of our employees are spread a lot, half of them [ph] are so big emerging markets of the world, 35% are in developed markets. So, whenever there is an issue of labor tightness or increases in expenses and wages in a particular location, we hire in other locations. We have a lot of hedges between dollar versus non-dollar and the like. So, that’s why we are very comfortable with this expense base because of the nature of the franchise that is diversified and the nature of our cautiousness going into the market.

Craig Huber

Great. Thank you.

Operator

The next question comes from Russell Quelch with Redburn Partners. Please go ahead.

Russell Quelch

Yes. Thanks having me on. And I appreciate what you are baking into guidance in terms of asset values. But wondering to what degree the guidance assumes lower retention rates to come on subscription revenues in the rest of the year and particularly in Q4, please?

Andy Wiechmann

Yes. I would – as you know, the subscription base is slow-moving beast. And so even adjustments to the retention rate around the hedges or sales don’t have a meaningful impact in the current year. So, I would say the bigger impact for this year is really around asset-based fees.

Russell Quelch

Okay. Cool. Thanks Andy. And then just following up from that sort of related, what are you assuming you can do on pricing to offset any increase in cancellations or inflation in the cost base, please?

Andy Wiechmann

Sure. Yes. I would say that price increases continue to be at a higher level than they have been in recent years, and they continue to contribute a larger percentage of new recurring sales. We have been successful with capturing price increases with clients. And we actually, in the first quarter, probably even saw a slightly higher contribution to recurring subscription sales than we even saw last quarter. I would say we will continue to be measured on this front and ensure that we are delivering value to our clients in connection with price increases. But where we are delivering value, we will continue to extract price and seem to be getting traction with it.

Russell Quelch

Okay. Good stuff. Thanks.

Operator

The next question comes from Greg Simpson with BNP Paribas. Please go ahead.

Greg Simpson

Hi. I appreciate you taking my questions. And can I just ask if you can share some thoughts on the potential implications of AI for MSCI longer term? What are you doing today? What applications are you exploring actively? I know it’s a broad question, but just would be interested to hear your thoughts there.

Baer Pettit

Sure. So look, we are actively – have quite a few projects going in AI across everything from client service, where we think it has great applications in reading our enormous amounts of methodology books and complex formulas and etcetera and giving clear answers. We are working on it – with it in ESG and all of the data applications that can go there. I mean there is a whole list of it, but we are extremely focused on it. And we would love to tell you more clearly in a slightly different context, but we are definitely very focused on the use of AI across the business.

Greg Simpson

Great. Thank you. And it seems like fixed income is an asset class that you are seeing a lot more interest from investors in this higher rate environment. I think you got $79 million in run rate. Can you just talk about which parts of MSCI that comes into? And are there opportunities to add more scale here since it’s growing past its relatively small part of your total business?

Baer Pettit

Yes, for sure. So, it’s both a very important part in our analytics story, both on a standalone basis and as part of multi-asset class risk. And we are really doing a lot of innovation in index. We are clearly starting from a tiny base, but we have got some really exciting things going on there related to ESG and climate, relating to liquidity. I am actually seeing a client this evening for dinner related to some credit and fixed income opportunities. So, we think it’s an area where people are very excited to see us bringing things forward, and I think it will be important part of our growth story going forward.

Greg Simpson

Alright. Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Henry Fernandez for any closing remarks.

Henry Fernandez

Thank you for joining us this morning. As you heard us say, our all-weather franchise continued to perform well in this challenging operating environment. These are times when companies differentiate themselves, these are times of opportunity, sometimes more than risk. And that’s what we are fully intending to capitalize on, and we will be more than happy to keep you abreast of all of that in future calls. Thank you very much again and have a great day.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may all now disconnect.