Spruce Point Capital short position on MSCI highlights concentration of index providers

Spruce Point Capital Management is shorting MSCI, citing "grave concerns" about the $48 billion index provider's business practices, but financial markets have so far been unfazed.

The New York-based hedge fund, which focuses on forensic research and short selling, published a 123-page report Jan. 17 claiming that MSCI has engaged in a string of "value destructive" acquisitions, used "aggressive accounting" to stretch its financial performance, and is facing existential threats including increased competition in the indexing business.

Spruce Point Capital declined to comment on the size of its position in MSCI, but projected that the company's stock could fall 55% to 65%.

Outside of passive asset management giants such as Vanguard Group and Blackrock, which are the top two holders of MSCI, several pension funds including Colorado Public Employees Retirement Association, Denver; Japan's Government Pension Investment Fund, Tokyo; Singapore's Temasek; and South Korea's National Pension Service are among the top 100 largest shareholders of MSCI.

The market, however, registered a mild reaction to Spruce Point's report — shares of MSCI fell less than 1% on Jan. 17 before rebounding the next day. At the time of publication, MSCI's stock was up 5% to $565 per share from the date of the report's release.

"I do think this report brings up some interesting points, but many of these allegations are either old news or not important to the level that you can short the stock and believe that it's a 50% or 60% downside to the stock," said Owen Lau, an analyst for Oppenheimer & Co., who covers MSCI and rates the company "outperform."

Lau acknowledged the risk of downward pressure on MSCI's fees but said he's not currently worried about competition from other index providers having an impact on MSCI's revenues.

"If you were telling me there's a new index provider that provides substantially lower fees than MSCI and people were moving away from MSCI, I would be worried about that. But right now, MSCI is still in a prime, very leading position in the benchmarking business for global indexes," Lau said.

Lau wasn't concerned about some of Spruce Point's allegations of "aggressive accounting," including potentially using segment reporting to "manipulate margins to its benefit."

Lau said that while his firm takes segment margins into consideration, the overall margins for the business are more important — and harder to massage through accounting practices.

"It's not like, not important, but, No. 1, I don't think they have enough evidence to make that claim," Lau said of Spruce Point's allegations. "And No. 2, we also look at overall margins and these kinds of accounting gimmicks cannot hide if there's a margin contraction."

Though the market has shrugged its shoulders at Spruce Point's report, the hedge fund and its founder, Ben Axler, remain steadfast in their price predictions for MSCI."Our report and price expectations are long-term in nature, and we expect that MSCI's share price will underperform the market given its rich valuation and growing challenges across its business segments," Axler said in an emailed statement.

In addition to accusing MSCI of massaging margins through accounting gimmicks, Spruce Point's report alleged that the company has made a series of questionable and "nepotism-like" acquisitions — including data and analytics provider Burgiss Group and tech platform Fabric last year — it described as "expensive blunders."

Spruce Point's report also highlighted connections between the acquired companies, MSCI, and Morgan Stanley, from which MSCI separated in 2007. Jay McNamara, the president of Burgiss, was a former executive committee member at MSCI before joining Burgiss. Fabric's co-founder Rick Bookstaber was formerly the first chief risk officer for Morgan Stanley.

In addition to questioning MSCI's acquisitions, Spruce Point insinuated inappropriate ties between MSCI and Royalty Pharma, which it claims MSCI pays for advice on science-based thematic ETFs.

MSCI's Chairman and CEO Henry Fernandez became Royalty Pharma's lead independent director in 2021 — and, according to the report, his son got a job at the pharmaceutical company around the same time.

Spruce Point's report also raised red flags over the recent departure of several high-level financial executives at MSCI, including former CFO Linda Huber — who jumped ship to competitor FactSet in August 2021 after a mere 15 months at MSCI — and Jennifer Mak, former global controller and chief accounting officer, who departed last September. According to Spruce Point Capital's report, MSCI has not yet named a new global controller.Beyond questioning the fitness of MSCI's corporate governance, Spruce Point's report also cites a host of external factors that could put pressure on MSCI, including growing competition in the indexing space and the growing role of self-indexing, which firms like BlackRock — MSCI's biggest customer — have been experimenting with since 2017.

MSCI and other competitors have an advantage: the ETF indexing business is highly concentrated among a few large index providers.

A recent paper co-authored by Yu An, Johns Hopkins business school professor, tracked the five largest index providers in the U.S. equity ETF market — S&P Dow Jones, CRSP, FTSE Russell, MSCI and NASDAQ — and found they capture in aggregate about 95% of the entire ETF market.

"Our results show promoting competition among existing index providers could significantly benefit end ETF investors," and lead to lower costs, the authors noted.

The Securities and Exchange Commission and the Financial Conduct Authority in 2022 called for studies about disclosure and competition in the index provision markets in the U.S. and the U.K., the academics added.

An MSCI spokesperson told Pensions & Investments that the firm "categorically refutes the claims" in Spruce Point's report, calling it an "intentional attempt by a short seller to target our stakeholders with misleading, incomplete and false information that aims to distract from MSCI's successes and opportunities."

"MSCI has a strong culture of compliance and ethics grounded in our code of conduct and our commitment to leading corporate governance practices, demonstrated through our robust financial controls and transparent financial reporting," the spokesperson added. "We remain focused on meeting our clients' needs and bringing innovative tools and insights that drive greater clarity for the global investment community."