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Greece's Potential Impact on Funds

With a potential Grexit looming, we take a look at Greece exposure across equity and fixed-income funds.

The four-years-running Greek debt tragedy is rapidly nearing its end. As negotiations to refinance Greece's bailout financing broke down, Greece was unable to meet its debt payment due at the end of June, and the European Central Bank would not increase the size of its emergency lending assistance program. Greece's prime minister called for a national referendum on Sunday, July 5, that asked voters whether the country should accept the European Union's conditions to extend further financing. Sixty-one percent voted "no." As high-stakes negotiations continue, Greece has imposed restrictions on ATM bank withdrawals and Greek banks remain closed to stem a bank run.

How Exposed Are Mutual Funds? Whether or not Greece exits the eurozone, the impact on mutual funds will likely be contained. Few fund managers own Greek bonds or equities in their portfolios. Recently, just 7% of U.S.-sold open-end taxable-bond funds had exposure to Greece, mostly world-bond funds, and the average stake was a scant 0.3%.

Looking at comparable funds sold in Europe, a mere 0.2% owned Greek debt, a much lower figure given the larger universe of bond funds available in the region. Among Morningstar Medalist funds globally, only 6% had exposure to Greece, and the maximum stake was just 1.3%.

A larger percentage of equity funds have exposure to Greece--most of those hail from the Europe-stock and diversified emerging-markets categories--but the funds that do tend to have tiny stakes. (Greece was relegated to emerging-markets status by MSCI in 2013, the first time a developed-markets country has been downgraded to emerging status by the firm.) Around one fifth of non-U.S. equity funds sold in the United States had some Greece exposure, but, on average, it was a mere 0.5%.

Just 0.4% of equity funds sold in Europe recently had exposure to Greek equities. And among funds earning Morningstar Medalist ratings, just 3% of the equity funds have Greece exposure, with the highest exposures in the mid-single digits. It's not surprising that equity managers have steered clear: Because Greece lacks the major multinational firms that managers might find attractive because of global footprints, an investment in Greek equities is tied to an economy in shambles.

While exposure to Greece won't hurt most funds in the near term, pressure on more commonly held securities from Europe's periphery could come under pressure. For instance, among U.S.-sold funds, Italian and Spanish debt can be found in nearly one third of taxable-bond offerings, with an average stake around 1%. And stocks from those countries can be found in more than half of non-U.S. equity funds, where a 2% stake is typical.

Grexit Today Not as Risky as During the European Debt Crisis Over the past couple of weeks, prominent asset managers covered by Morningstar analysts have indicated that general market liquidity has suffered and volatility is likely to remain high in the weeks ahead as Greece continues to try to reach an agreement with the ECB and International Monetary Fund. Equity markets posted single-digit losses over the past week through June 30, with MSCI Europe losing about twice as much as the S&P 500. European yields and spreads have been relatively contained thus far.

Morningstar's credit team does not think a Greek default and possible exit from the eurozone will have a significant impact on credit spreads in the corporate-bond markets or lead to systemic financial crisis. That's because, unlike four years ago during the European debt crisis, real gross domestic product in the eurozone has been expanding, albeit at a very modest pace, and the banking system has been able to shore up its capital levels. In addition, 75%-80% of Greece's debt is now owed to official creditors such as the IMF, ECB, EU, and other financial bailout vehicles.

Further, lower default risk in the banking system should mean less pressure on sovereign credit spreads for the peripheral countries. And today, the EU and ECB have more tools at their disposal to fight contagion, including the ECB's asset purchase program, which will continue to add liquidity into the European markets as well as potential issuance from the European Stability Mechanism.

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