In Good Company with Nicolai Tangen - Henry Fernandez CEO of MSCI

Episode Date: January 25, 2023

In this episode, Nicolai Tangen talks to Henry Fernandez, CEO of MSCI, one of the largest index providers in the world. Nicolai and Henry discuss the power of index providers, and do they have too much influence? ESG investing and the current backlash in the US, will it remain? And Henry share many interesting personal stories about his upbringing and relationship with his father.The production team on this episode were PLAN-B’s Martin Oftedal. Background research were done by Sigurd Brekke with additional input from Truls Oppedal. Links:Watch the episode on YouTube: Norges Bank Investment Management - YouTubeWant to learn more about the fund? The fund | Norges Bank Investment Management (nbim.no)Follow Nicolai Tangen on LinkedIn: Nicolai Tangen | LinkedInFollow NBIM on LinkedIn: Norges Bank Investment Management: Administrator for bedriftsside | LinkedInFollow NBIM on Instagram: Explore Norges Bank Investment Management on Instagram Hosted on Acast. See acast.com/privacy for more information.

Hi, everyone, and welcome to our podcast, In Good Company. I'm Nikolaj Tangen, the CEO of the Norwegian Southern Wealth Fund, and your host today. In this podcast, I talk to the leaders of some of the largest companies we are invested in so that you can learn what we own and meet these impressive leaders. Today, I'm speaking to Henry Fernandes, the CEO of MSCI, one of the world's largest index providers. MSCI and the index providers are an underappreciated power in finance, and that power is only likely to grow. And Henry, he has the front seat.

We own almost 1% of MSCI, translating to over 3 billion kroner or $400 million. Henry, as a truly fascinating individual, stay tuned. Well, Henry, really a big thanks for taking the time to talk with us today. It's a real pleasure having you on. Thanks for having me. When you established MSCI, indexing was a sleepy industry, and your company was valued at $20 million. Today, you are one of the world's largest providers of indices and valued at more than $40 billion. So incredibly, incredibly

impressive. And you're kind of the central connecting dot for global investment industry. So really interesting to talk to you. But let's just start with the very basics, because it's not so obvious to understand how you make money. So first of all, what's an index? So basically, an index is a collection or a basket of securities that represent a particular market. That market can be Norway, can be Europe, can be the world, can be emerging markets. can be Europe, can be the world, can be emerging markets. And the way we look at each security, the weight or the percentage of that security is measured depending on its full market capitalization with certain adjustments like float and the like.

So that's what these indices are all about. We applied a couple of filters for investability and float and foreign ownership. You know, there's some companies that have limitations on foreign ownership and other companies that have a lot of securities,

but, you know, they don't trade. So we applied certain liquidity and investability filters, as we call them, but that's what indices are all about. Why do we need indices? Indices are representations of markets, and in some respects, they represent general equilibrium, so to speak.

Demand meets supply. The demand for security meets the supply of securities at a particular price. at a particular price. So if you are looking for just an exposure to a market, let's say Europe, you buy the market, you buy the indices. So the interesting thing is that a lot of people say, they ask you every day, what did the market do? Not a lot of people know what markets do, because it's a lot of securities,

but what people will know what the msci europe index did you know what the msci emerging markets did so a lot of references to measurements of markets to the performance of markets is all related to indices you add the value of all the companies and make it into one number basically yes and why is it so important in the investment industry to do that well there was a lot of skepticism in the 90s as to whether uh you know indexed investing represented any value added you know in the investment process and uh and there were you know a number of people that were optimistic that it will add value over time. And the optimists obviously

were right. And the reason is that it's very hard to beat the market, as you know well. It's very hard. I'm trying every day, Henry. You're trying very hard, right? I try my best. It's what I do for a living. But Henry, let's change tack a bit here. So tell us about your upbringing, because you were born in Mexico and raised in Nicaragua, I believe. Yes. So I was born in Mexico and left

as a child. I was probably three, four years old. My father was a diplomat there for a brief period of time but you know my parents were nicaraguan my father was a uh the grandson of a spanish immigrant and my mother was the granddaughter of a french immigrant uh into uh nicaragua uh central america so uh so i grew up in nicaragua until i was 16. and uh you know and it was a very interesting it's a small country, right? And not unlike Norway, but it's a country that was always in social turmoil and political turmoil. So I grew up there with a conscious

that it was important to be an agent of change in the world. So some people asked me, what were motivations when I was growing up besides making sure I didn't get in trouble. And it was, can I be an agent of change? And initially that motivation was a social political change. But unfortunately, the country went, you know, socialist in a violent revolution. So that's when I emigrated to the U.S.

What happened with your father? Well, my father was actually a member of the military. There was a civil war between the two sides and, you know, his side left and they, you know, the whole family, you know, left the country because we were free market people. We were, you know, pro-capitalism, so to speak. And a lot of the people that ended up winning were socialists and had a different view of organization of society and organization of the country, right? So we emigrated and my father is now 96 years old. I'm going to see him in a few weeks. My mother passed away at 92 a few years ago. So hopefully, they tell me I have, you know, good genes, so I got to make something good out of those genes.

Where did your ambitions come from? When I was growing up, my father was an orphan and then eventually joined the military academy and made a career in the army there. he tried to pass on to me a sense of purpose, a sense of mission in life, you know, because of all the hardships that he had had. And I took on to that, you know, I took on that ambition, that desire to make a difference in the world. I remember when I was in my late teens traveling through Europe and going to Greece, for example, and going to Rome and going to other places and looking at all these civilizations that have been created. And I said, what will my contribution be in a small, very small way? So a lot of us go through life and many of us, obviously, the vast majority of people in life have to put food on the table to feed their family and survive. But some of us were privileged to have had an education and an upbringing.

And the question becomes is, what are you going to do with that? So when you are in your 90s and you're sitting with your grandchildren and your grandchildren say, Grandpa, what do you do in life? What answer would you give them and let's talk about the power of index providers now some statistics show that the that as much as 40 percent of the total assets managed by funds in america are now passive now how is this impacting the markets i think index investment is this impacting the markets? I think index investment is one of the best things that ever happened to our civilization. Why?

As long as the institution has assets, that institution will be invested in that company. And as that company has a market cap. So that makes index investors the definition of long-term investors. Is there a limit to how big passive investing can be before it becomes problematic? I don't know where the limit will be, Nikolai, but it is far, far from what it is today. You could have a minority or even a small minority of active investors creating liquidity,

so to speak, in the market, creating bid and asks and having different points of view about the value of that company. And I still have a large percentage of indexation going on. And if anything, I believe that indexation will continue unabated for a long time to come. And there are a lot of new frontiers of investing that are coming that are going to get that number that you mentioned, like 40% or whatever number, significantly higher. Let's move on to ESG investing. So talking about climate and environmental and governance issues.

Now, you were an early mover into the ESG space. How did that come about? Believe it or not, it all started in Oslo, Norway. There we go. I was living in Geneva, Switzerland, having recently taken over this money-losing product line called MSCI Equity Indices. And there was a fellow, a store brand, who called me up and said that he had an international portfolio that he was running and that he needed uh you know that was according to sri principles you know what they call at the time socially responsible investing principles

and that um that we should create an index and And Storebrand is a Norwegian insurance company, just for information. Yeah. So he was saying, can you build us an index so that we can measure the performance of this? So I said to him, well, we don't know anything about this, but what we can do is take your research, analyze it, and build an index based on your research. analyze it, and build an index based on your research. So he and Storer Brand, you know, there have been a number of other Scandinavian clients that have been calling, and we have been ignoring them

to some extent, but it was Storer Brand who actually got to the point in which we said, this is something that is coming. This is something that makes sense. So when I got into it, you know, as an economist that I was, you know, in my prior life, I began to analyze ASRI then and now ASG investing more on economic terms, which was any economic system creates externalities. And the benefit of free markets is that you need to be able to incorporate all available information about companies and their externalities and try to cost them out into the pricing

of assets so that it will lead to a better allocation of capital and therefore better economic growth. So, Henry, do you think you need to invest sustainably in order to get high returns? Yes, 100%. And the reason is that these externalities that are being created need to be factored into the cost of capital of those companies and to the pricing of the assets of those companies and therefore into the allocation of capital of those companies and to the pricing of the assets of those companies and therefore

into the allocation of capital and if you don't do that and you ignore those costs and therefore you invest in a company or you lend money to a company based on the wrong or lower cost of capital and then the things then you know get internalized your return is going to be lower. We could not agree more. But there's been a bit of a backlash lately in the world, in particular in America, against ESG and responsible investing. How do you think this will pan out? Well, I think it has been politicized.

Should it be politicized? Is it a political question? Well, ESG has to be political. Why? Isn't ESG just common sense? Yes, but the reason I said that it has to be political is because, you know, my definition of politics is the, what is the best organization in a society? What is the best in ways of dealing with, let's say, the different cultures in a society, the different, you know, now, as we know well, a business, whether it's a dry cleaner or a restaurant or a multinational, is the unit of economic organization in a free market society, right? So, you know, so therefore society should be interested in the way that the economy is organized, right? A lot of businesses in a society

have a license from society to operate. So anything having to do with social issues, how do you treat minorities? How do you treat handicapped people? How do you treat social environments in companies? It is the purview of politicians. We have to recognize that it will be political. But do you think it's a temporary backlash or you think it will be a lasting backlash?

No, it will continue political. But do you think it's a temporary backlash or you think it will be a lasting backlash? No, it will continue. It will continue. Because then the second part is, you know, is we in the capital markets, we're not in politics, right? We're in the capital market. We're in the investing business. So the question is,

how do we apply those principles in our own lane? You know, our lane is not politics. Our lane is providing high returns to our fiduciaries, to the people that entrust the capital to us. So therefore, the way we apply those principles to our own lane is along the lines of saying, well, I am not a government agency. I'm not an NGO. I am an investor. And therefore, I'm going to incorporate these ESG principles that are applicable to a society, to my way of investing, so that I can achieve sustainable, short, medium, long-term returns to my fiduciaries.

Okay. left, you know, the extreme left, have tried to use ESG as a way to change the mandate from the people that give you capital, to use the capital to fight social causes and other political battles. And then the right is now countering that and saying, no, all of that is a threat to democracy, it's a threat to free markets, it's a threat to capitalism, because they see it as a counter reaction to a lot of this. So we take a slightly different view on this. We think that ESG has nothing to do with politics.

We think it's all about common sense. But that's exactly what I was saying to you. The reason I'm mentioning this in politics is because ESG is way beyond capital markets. ESG is about a society holding all its institutions accountable. It's about the future of mankind, no? Yes, it's about, you know, but also let's think about this. The reason I go through that whole process, Nikolai, is that it will be, you know, the ESG as in its general form

will be political and it will continue to be political. How does geopolitical tensions impact your work? So the business that we are in at MSCI is in the free flow of capital in the world. We are a company that helps our clients mobilize capital from low return investments to high return investments, from high savings countries to low savings countries that provide a good investment opportunity. For instance, when you include China in the World Index,

a lot of people have to put money into China, right? Yes, yes. And you have been criticized for that. Yeah, we've been politically criticized because people say, you know, China is not a free market. You know, it's got, you know, a regime that they don't like. I understand all of that, you know, and I respect that. But at the end of the day, China is open for investments.

It is investable. And we are going to put it in our indexes. But, you know, that's an active management decision by an investor. What was the thinking behind taking Russia out? Totally uninvestable. As we discussed, the definition of an index, it has to be investable. You have to be able to buy and sell the securities. And to the extent that you're frozen and you can't take your money out, you can't sell to anybody because of the sanctions. Therefore, the investment is rendered worthless. And that is, of course, the situation we are in as the Sovereign Wealth Fund,

in that we have assets in Russia and we cannot divest them because there is no trading going on. What do you look for when you recruit? First of all, we have about 5,000 people in the company in 20 plus countries. And therefore, we have large presences in some big countries. We have not been very good at recruiting directly from undergraduate or directly from graduate school. We try to hire people with graduate degrees that already have a minimum of two or three years of experience. They know what they're looking for. They know what they want. And now as we grow, that scale, that model will be challenged.

You know, we'll have to recruit directly from university. But a lot of our people have graduate degrees and we bring them into the company. But the key thing here is absorb them into the company right away. into the company but the key thing here is absorb them into the company right away secondly respect if you if you spend so much time looking for somebody to hire them you're not going to come and tell the person what to do you want them to tell you what they what they want to do they'll tell you to go through so now i'm applying it for a job at msi what are you going to ask me when i interview people i i ask them questions, what do you want out of life? If you have a problem in your family, how are you going to solve that problem?

If you have a problem in business, how are you going to solve it? Now, these are very generic questions that the person being interviewed sometimes doesn't know what I'm looking for. But that's what I want. I don't want a prescribed answer. I want an ability to see how that person thinks, how that person that, you know, importantly is, what do you want to achieve in life? You know, but anyhow, we like people that are eclectic.

We like people that are passionate, people that are intellectually curious, people that are not afraid of innovating and not afraid of asking the the tough questions or even the simple questions because you know a lot of our clients as you know well are the smartest people in this world and we need to match them with smart people from our side what do you think about remote working i love it are you working from home today? Yes, I am. I probably go to the office once a week nowadays. You know, gradually I travel a lot now because the world has opened up. My team is global. I mean, you know, the corporate headquarters is in New York and I have a few people in New York, but I have a lot of people in London,

I have other people in Geneva, other people, you know, in California. But I'll tell you one thing, Henry. Your biggest client, who is Larry Fink, we spoke with him the other day. He does not believe in remote working. When the pandemic hit, there were two shifts that took place. The first shift was that you went to work virtually. And the second shift, that the base of your virtuality,

so to speak, was your home. So MSCI had already made the first leg of that, which is we were virtual, but working from offices. The only thing the pandemic did, which was a big deal, obviously, was that instead of, you know, two people in one location working with 10 people in other locations working virtually, that it went, you know, from being in the office to being at home. There is a limit for sure of what somebody can do in the hybrid world. So the combination of those two are going to be, it's like the risk and return. Where do you want to be in the efficient frontier?

There are a lot of different places to be in the efficient frontier. In our case, we are a smaller company. We're searching for talent all over the world. And our ability to offer remote working has improved dramatically our ability to attract talent. But there are no bricks and mortar. There is no physical presence. No office. No office.

Wow. Do people like it? They love it. No office? No office. Wow. Do people like it? They love it.

Spending a bit of time on leadership, how would you describe your leadership principles? Lead by example. I normally don't ask anybody to do something that I'm not prepared to do myself. Secondly, leadership sometimes means solitude of decisions, but doesn't mean solitude of debate. How you create an environment in which people feel safe to debate matters, to bring things that they're not going to be fun or people people are going to make fun of them or this or recriminate them or whatever. Three to me is yes, there is the focus on the leader, but sometimes you have to take away that focus and put the focus on the team.

You know, sometimes leaders tend to take credit for a lot of what they do. I support, but a lot of the work is done by their teams. I at MSCI, since I created the company, was very conscious that I wanted to institutionalize the company. When people would come to me and say, I came to MSCI because I wanted to work for you, Henry, I normally tell them, no, you don't work for me you work for mci you work for our institution you work for our company on one hand leadership is about personalizing the touch and

the involvement but on the other hand you got to make sure that you're creating a company that will survive you know your tenure in the company so it can go on and build greater things. Leadership to me also is about values and principles. Which values and principles? Fair play, honesty, accept mistakes, recognize the bad things you may have done, give credit to people, respect somebody's opinion uh you know don't infringe in the freedom of others you know and the like and those sounds like cliches the question is do you live those values and principles so in my mind you know you have to do the right thing regardless of the consequences you know and i've had a lot

of examples in my life in which i i've had to do things in which have hurt me uh and you know either personally or financially or you know family wise you know because it's the right thing and you gotta accept the pain or you gotta accept the price you know to pay for that that's when those decisions that's when the real test comes when you have to make a decision what are your shortcomings you know sometimes i can be a little you know opinionated you know and and the the reason that becomes important is because you have to restrain that in order to create space and room for a good debate, you know, with others.

Sometimes I can get, you know, pretty passionate and, and I'm, I'm a Latino by background. So sometimes you can get emotional about, about things and you got to sort of tone it down so that people don't think like you're upset.

Right. And, and you create you know a reverberation through uh through the thing you know i'll tell you i'll tell you one thing i can be a bit latino too what do you think the norwegian someone wealthWell Fund can do better? First of all, you've done a phenomenal job. For my predecessors. Yes, you meaning the Norwegian Fund have done a phenomenal job.

I mean, think about my own backyard, Central America and South America. Venezuela had the ability to create an endowment like you did and make it last for generations to come. And they did it. So the first thing that the country has done is the ability to be disciplined about putting a pool of money on the side, running it, let it run professionally, keep feeding into it, and each successive political party hasn't used it as a piñata to go out and fund, you know, to go out and pull money out. I remember many years ago when in Argentina, they had spent 15 years putting money into the fine contribution plans of individuals. And then the central bank went in and grabbed the money. 15, 20 years of savings, you know, the central bank grabbed the money in order to pay debt or whatever. So that discipline, it starts there, right, to begin with. That is a

social choice. That is a political choice that the vast majority of countries haven't done well at all. And some have done well, but not to the same extent as you have. The second part is obviously how you run the fund. And the fund has been run with meritocracy, with people that are professionals, overseen by professionals and the like. And as you know, in many pension funds around the world, you know, the overseers don't even know anything about investment, right? You know, and that becomes a big problem because there is a disconnect

between in the governance. In terms of investments, I think that, you know, clearly you're large and therefore impact markets and therefore there is a tendency to put money in passive and in liquid investments like, you know, equities and bonds or things that are tangible like real estate. The world is a lot bigger than that. I think that given your size, you will do well by following a little bit more of the Canadian model, for example, which is actively managing more of the portfolio, going into new areas that are not going to, given your size, are not going to hurt you. infrastructure investing. You are so sophisticated, you're so large, and you run the fund so well that you have the discipline to be able to look at newer investments that are going to create higher return for you compared to what you're doing today,

higher return for you compared to what you're doing today, but you're giving them up because I think your investment scope is too narrow. You could definitely start expanding your horizon and create a higher return. And at the end of the day, if you end up with a 25%, 50% return higher for 10 years, that is an incredible amount of money. Absolutely. Henry, last question. We have a lot of young listeners to this podcast. What is your advice to young people?

Follow your passion. There is no life less fulfilling than to follow a career that your parents gave you, that your siblings gave you, or that your friends gave you. Follow the thing that is going to motivate you. Follow the thing that when you wake up every morning, you are going to be excited. You are going to go give everything you can.

You know, work is already difficult enough with so many challenges and all of that, that if you wake up and you don't want to go to work because you don't like what you do, that's a tragedy. So follow your passion. Secondly, is once you have that passion for that, throw everything you can at it. You know, be the best you can at it. If you were to ask me, what are the two or three regrets that I've had in life? One is I should have taken more risk. You know, I should have taken more risk by speaking, you know, my mind, by investing in this thing or by this.

And risk tends to magnify in a short period of time. But when you look at it in the context of a longer term, you know, risk kind of dissipates a little bit. So take risks. If you're really passionate about what you do and you take risks, and for some reason the risk pans out, you know, negatively, you're going to recover, you know, no problem.

You know, you're going to find another job. You're going to find, you know, because your passion will be there. The last point is clearly all of us have responsibility to our families to our children you know you know you gotta make money to put food on the table pay for education and and things like that but try to be an agent of change you know in the world if you're 90 years old, nobody is going to ask you, what was your salary when you were 50? What was your compensation when you were 35?

Well, people are going to ask you, what do you contribute to make the world better? That doesn't mean that you end up in a career in government or an NGO or whatever. I actually believe that the vast majority of the contributions to our societies are in the private sector. How is the world going to remember you, Henry? Well, I hope that, you know, what my tombstone will say, right? Nice guy, we miss him, he was fun, but, you know, he made a difference in the world. His life. So I want people to say his life made a difference. He devoted his, you know, passion, his energy,

his skills to the right cost and that made the world and society move an inch closer to being better and his life was worth it. That this person was born and eventually died and that trajectory that this person was born and eventually died. And that trajectory through this planet Earth was not in vain, that it made a difference in the life of others. That's a wonderful place to end this podcast.

A big thanks for sharing your thoughts and for all the great things you're doing. Thank you. Thank you for having me.