Turkey’s Long-Unloved Debt Is Starting to Win Over Investors

Some of the biggest and best-performing emerging-market bond investors are back buying Turkish debt.

The rise in appetite for Turkish debt comes after a period of continuous unloading since September 2018, when foreigners owned 20% of Turkish debt. That share shrank to an all-time low of 3.3% in November, but has been climbing since then.

Pacific Investment Management Co., Amundi and UBS Asset Management see the potential for a lucrative year ahead for Turkish debt, betting that interest-rate increases will help reduce inflation and slow credit growth, two key concerns for bondholders. That would be a U-turn from 2020, when lira weakened for an eighth straight year and local bonds lost 13% as President Recep Tayyip Erdogan backed loose monetary policy.

Investors are betting that Erdogan, though still in favor of low rates, will nevertheless let his new economic management team get on with their job. Central-bank Governor Naci Agbal, who took the helm in November, pledged to follow a more orthodox monetary approach, and hiked the policy rate twice last year to curb inflation and stem the lira’s slide.

“We think now it is a good time to invest in Turkey,” said Pramol Dhawan, Pimco’s Newport Beach-based head of emerging markets, whose fund beat 96% of peers over the last five years. “The policies we have seen were in the right direction, and as long as Turkey follows through these policies, it can be a beneficiary of the favorable external environment for emerging markets.”

In a vote of confidence for the new economic team, foreign investors added $3.1 billion worth of Turkish lira bonds to their holdings since November. They were net buyers every week between Agbal’s appointment and Jan. 8, with the weekly flows hitting a 2017-peak on Dec. 18, according to the central bank data.

The purchases raised the share of foreign holdings of Turkish domestic debt to 4.4%. That’s still very low in global terms: non-residents own 24% of Russian bonds, 30% in South Africa and 48% in Mexico.

Amundi and UBS have also raised Turkey to “overweight” in their emerging-market debt allocations. Vanguard Asset Management, whose EM debt fund beat 99% of its peers, closed all its short-lira positions after the second rate hike late last year, said Nick Eisinger, the London-based co-head of emerging-markets active fixed income.

“Turkey has started to do the right things recently,” said Hakan Aksoy, Amundi’s London-based senior fund manager for emerging-market sovereign bonds. “It has a beaten-up currency and a very high carry. At a time when yields are negative globally in many nations, the central bank is hiking interest rates, promises reforms and this makes us excited about the Turkish market.”

Turkey attracted record demand for its first Eurobond sale of the year, raising $3.5 billion via a two-part offering of dollar-denominated securities. Demand for the securities was more than $15 billion, an all-time high for a Turkish issuance in international capital markets, the country’s Treasury said in a statement on Jan. 20.

Even so, some emerging-market investors want to see more evidence of a turnaround.

‘More Consistency’

“We are not constructive yet,” said Gustavo Medeiros, the London-based deputy head of research at Ashmore Group Plc. “So much damage has been done in terms of central-bank credibility, foreign investor confidence and valuation of the currency in recent years. We need more consistency in monetary and fiscal policy to regain confidence in the market.”

The biggest unknown for bondholders is how long Erdogan, who fired two central-bank governors in the past two years, will let the regulator keep interest rates high. He repeated his opposition to high interest rates on two separate occasions this month. That’s a risk nobody can predict, and investors should rather look to the fundamentals, said Pimco’s Dhawan.

“If you pursue a more moderate growth, which is in line with the economic realities of Turkey, then foreign investors will come in,” he said. “It is a huge and an under-invested economy and people want to be able to take that risk.”

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