Deutsche Bank andSchroder Salomon Smith Barney are recommending investors enter total-return equity swaps to take advantage of possible price changes following a rebalancing of the Morgan Stanley Capital International (MSCI) Europe index, details of which MSCI is expected to announce in June. The weightings will be changed in May 2002.
The trade idea has the caught the imagination of at least one hedge fund manager. Stefan Åsbrink, hedge fund manager at SEB Investment Management in Stockholm, said it is considering entering a swap in which it pays the total return of 5-10 blue chip stocks reducing their weight in the index and receives the return of 5-10 blue chip stocks increasing their weighting.
The hedge fund would put the trade on just before the announcement in June and unwind the trade a couple of weeks after. The swap would be approximately EUR5-10 million (USD4.5-9 million, notional) per leg. Åsbrink said SEB's decision to enter the trade will depend on the availability of other market opportunities. He plans to speak to the major banks about which stocks to pick nearer the time. In the trade Åsbrink wins if the price of the shares increasing their weight in the index rises and the price of the shares losing weight in the index falls.
Investor demand for swaps designed to profit from the rebalancing is expected to broaden from hedge funds speculating to tracker funds rebalancing their portfolios, said Dharmendra Patel, equity derivatives strategist at SSSB in London. Although the plans to rebalance the index is generally known, the precise reweightings have yet to be announced, added Nazim Hamid, director of portfolio and index research at Deutsche Bank in London.
Both Patel and Hamid said the exact make up of the basket will depend on investors' opinions on sectors and countries. But Hamid said a typical long basket would contain large cap European stocks, such as Royal Dutch/Shell Group and Cable & Wireless, which are increasing their weight in the index, and a typical short basket would contain Deutsche Telekom and Allianz, which are decreasing their weight in the index.
