Heads Up For Some Early End of Month FX Clues on the MSCI Rebalancing
Semi-annual index rebalancing can set the tone for the month-end fix moves
First the background
The MSCI is a series of global index analytics. They create baskets of stocks (indexes) of sectors, countries, firm sizes etc etc, and provide a wide range of tracking and performance analytics for hedge funds and institutions. They also form the basis for a lot of ETF’s. Thus hedge funds and the like can trade stocks which get benchmarked to the relevant indices and they get the detailed information they need to make judgements on their holdings.
The stocks within each index is weighted, so the biggest market cap firms get the highest weight etc. It has grown so big that some firms will actively trade the shares in these MSCI indices just because they’re in them, so if the MSCI bods decide to drop or add firms to any of the indices, and firms have exposure to those stocks, they will often adjust their portfolios to match. There can be other modest changes due to the changes of weights, as firms market caps grow or shrink.
All in all, the MSCI is a sort of global standard and if they change their analysis and index makeups, firms can make the same changes in their positions, hence we get rebalancing. MSCI perform these reviews on a quarterly and semi-annual basis, and it’s the semi-annual review that can bring the biggest changes.
There are a few banks who take their monthly equity analysis from MSCI for their month-end rebal & FX models, Citi being one example, so you get the idea on how big this all is.
Back in May the guys in our trading room picked up that there were some sizable changes in the Japanese and Chinese indices, so there was a decent amount of rebal happening in the stocks of those firms, which led to us seeing some hefty flows in those respective currencies.
What were looking for here first is if there are any big changes. 5 firms coming out and 3 going in isn’t that but if there’s big numbers moving e.g 30 out, 5 in, or 5 out, 30 in, then we have something to look closer at. Obviously there are a ton of caveats too. Just because there may be some big changes doesn’t mean we’ll see any FX impact. For example, if there are big shifts in several indices that are all USD denominated, the effects might be minimal. The impact may be more prominent in the non-USD indices. It’s also the case that FX rebal isn’t automatic and the cash may just be held instead, or shifted to other assets if the same currency (out of stocks, into bonds, for example).
One other caveat is that there’s a growing number of eyeballs waiting on these reports now, which means more folks trying to guess and front run any possible action, meaning it all becomes a mess, or we see the opposite to what we expect because it’s all been front run and the front runners will be trying to TP into the expected FX action..
The important dates
This evening sees the release of the next semi-annual index review notice from MSCI, and from that we’ll know the changes. That will mainly impact those particular stocks thereafter. The actual index changes will be made 30th Nov but firms will likely have been rebalancing in the run up to that, hence why we’ll see any possible FX fix impact on the EoM value date 2 days before.
This is yet another event that can have a wide market impact for assets, and that’s a feature that we need to look out for and be aware of. It may lead to something, it may lead to nothing but forewarned is forearmed. If you want any more information about all this, or indeed want to be part of our community who will be analysing it all as it happens, you can join us here.