Forced index fund sales of Greek debt likely

LONDON (Reuters) - Investors could be forced to sell billions of euros of Greek government bonds after Barclays Capital and Citigroup strip GGBs from indices following Moody's downgrade of the sovereign credit to junk status.






Moody's Investors Service cut Greece by four notches to junk status on Monday.



"Greece government debt will thus exit all Series-L investment-grade benchmarks (for example Global Aggregate, Global Treasury, Euro Aggregate, and Euro Treasury) on July 1, 2010," investment bank BarCap said in its statement on Monday.



It follows moves by Citigroup to drop GGBs from its World Government Bond Index (WGBI), another key sovereign credit benchmark series, after the Moody's downgrade.



But estimates vary wildly as to how much debt will be dumped by investors at the end of the month, and there is uncertainty as to the impact on Greek government debt prices.



"The four-notch ratings cut on Greece by Moody's takes GGBs out of most index-tracking funds. We estimate that total forced selling in GGBs could amount to some 30 billion euros," said Harvinder Sian, a bond analyst at RBS in London.



Huw Worthington, a bond strategist at BarCap in London, said a more conservative 2-4 billion euros may be involved as investors shun Greek paper no longer seen as investment grade.



Confusion reigns because of the many ways in which fund managers apply the indices to their portfolios. This in turn will make it harder to gauge how much or little the European Central Bank may need to buy in its efforts to maintain stable Greek bond yield spreads in the euro zone. The spread has meandered at around 500-600 basis points over Bunds since the ECB's operations began on May 10.



Around 200 billion euros worth of Greek government bonds are eligible for the BarCap and Citigroup indices, although not all of them are actually in indices.



"The exact amount is difficult to estimate. According to the Greek debt office, some 33 percent of GGBs have been allocated to fund managers and insurance and pension funds between 2005 and 2009," said Christoph Rieger, a bond strategist at Commerzbank in Frankfurt.



"Applied to the indices, this would add up to 66 billion euros. We believe the number that could actually be affected will be much smaller though as these accounts are likely to have reduced their holdings already significantly of late," he added.



ACTIVE MANAGERS ALSO USE INDICES



Not all fund managers have a licence to track the indices tick-for-tick.



"Many funds just benchmark to an index for the purposes of reporting to clients and are otherwise mostly or completely active fund managers who pick and drop bonds as and when they like. They are the ones who probably sold Greek bonds last autumn when the debt troubles first emerged," said one index specialist.



Another problem is that even pure "passive" fund managers, who track an index, are not obliged to hold every bond.



"There are instances where they can track the broad benchmark returns without actually holding some countries' debt throughout the investment period being measured," he added.



Citigroup said on Monday GGBs would be removed at the end of June after its index components are fixed on June 24 and said Greek bonds account for 1.34 percent of its flagship WGBI. The market value of Greek bonds is $213.6 billion.



JP Morgan Chase, which runs a rival bond index series, said in a note dated June 15 that GGBs were now eligible for its Emerging Markets Bond Index Plus.



Along with Citigroup and JP Morgan Chase, Barclays is one of the world's major index product providers. The indices are used by clients who want to maintain exposure to government debt without the need to actively manage their portfolio