If you think that the credit issue and risk in sovereign debt is going away any time soon, you better think again.  A small under-covered downgrade today is something which should be reviewed by those who are concerned about international sovereign debt ratings.  It might seem odd that ratings of ETFs and funds might see the same sort of collateral risks seen elsewhere as if they are financial institutions.  Standard & Poor’s Ratings Services has lowered its fund credit quality rating on the SPDR Barclays Capital International Treasury Bond ETF (NYSE: BWX).  This may sound irrelevant on the surface, but this is one of those calls that could have longer-term credit implications for all entities out there which have ties to weaker sovereign nations.

The actual downgrade is probably more symbolic than any ill omen.  But it should make you wonder which other downgrades are coming for ETF products and for business entities and funds which have high exposure to weaker international credit.  Today’s S&P downgrade was to ‘Af’ from ‘A+f’ while the volatility rating remains unchanged at ‘S4’.

S&P noted, “We lowered the credit quality rating because of an exposure of approximately 11% of the fund’s total assets to ‘BBB’ rated bonds that remain eligible investments for the Global Treasury Ex-US Capped Index… The index includes government bonds issued by investment grade countries outside the U.S., in local currencies, that have a remaining maturity of one year or more and are rated investment grade or higher using the middle rating of Standard & Poor’s, Moody’s, and Fitch.”

Also noted, “Our credit quality and volatility ratings are based on our analysis of a fund’s eligible portfolio investments and strategy, historical return volatility, and management. The fund credit quality rating scale ranges from ‘AAAf’ (highest level of protection) to ‘CCCf’ (least protection).  The ratings from ‘AAf’ to ‘CCCf’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories.

This particular ETF has over $1.1 billion inside its funds.  If you track the PIIGS, 11.8% of the ETF is Italy, Greece is 4.32%, and Spain is 4.55%.  The fund’s fact sheet shows the average credit rating of its securities is “AA2” and has a modified duration of 6.38.

Again, our concern here is the collateral fallout which could come up.  Having broad exposure like this will not kill an ETF, but there are many others out there with similar exposure.  Stay tuned.

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JON C. OGG

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