This ETF’s Fate Hinges On Greek Debt Crisis

by on May 14, 2010 | ETFs Mentioned:

Earlier this week, the European Union announced the formation of a bailout fund for struggling European countries, including Greece. The bailout will be worth 750 billion euros (nearly $1 trillion), including contributions from the IMF, and is meant to stop the international debt crisis that has destroyed investor confidence in European markets. Although the initial reaction to the bailout package was encouraging–within just hours raw material prices jumped 3.2%, the S&P 500 increased by 3.5%, and the Dow Jones Industrial Average gained 333.5 points–anxiety over the creditworthiness of sovereign debt has rattled markets in several recent sessions.

The recent turmoil in Greece has rippled throughout the global economy, impacting everything from SPY to DBC. But few securities have been as volatile in recent weeks as the iShares MSCI Europe Financials Sector Index Fund (EUFN), which looks to remain in focus as the drama in Greece unfolds.

EUFN tracks the MSCI Europe Financials Index, a market capitalization-weighted index designed to measure the combined equity market performance of the financials sector of developed and market countries in Europe. From a country perspective, the United Kingdom (29.3%), France (12.4%), and Germany (10%), make up a significant portion of the fund’s allocations. In other words, EUFN’s holdings consist of several financial institutions with significant exposure to Greek debt (also see Checking In On Six ETFs Touched By Chaos In Greece).

Possible Outcomes

The way the Greek debt fiasco plays out could have a huge impact on EUFN. If Greece and other countries (mainly Spain, Portugal, and Ireland) were to default on their debts, EUFN would likely see a large decline. But if Greece is able to pay the debt back in full, losses already priced in to EUFN may never materialize. The fund will likely have a volatile future if the past week is any kind of indication. At the close of last week EUFN had dropped roughly 6% in two days, and with the announcement of the bailout the fund rose by nearly 13% in just a matter of hours.

The manner in which the debt is distributed may also cause more volatility. “German and French banks carry a combined $119 billion in exposure to Greek borrowers alone and more than $900 billion to Greece and other countries on the euro-zone’s vulnerable periphery: Portugal, Ireland and Spain,” writes Vanessa Fuhrmans. This significant exposure helps to explain why Paris and Berlin have elected to pursue a rescue of Greece that has been extremely unpopular throughout both countries. “If Athens were to default, investors may question whether French and German banks could withstand the potential losses, sparking a panic that could reverberate throughout the financial system,” writes Fuhrmans.

Expect some big swings out of EUFN in coming weeks, as this ETF’s movements will amplify investor sentiment towards Greece. Also make sure to read Why The European Bailout Is Just Postponing The Inevitable.

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Disclosure: No positions at time of writing