High yields prompt wary investors to reverse Turkish debt

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Foreign investors have started tiptoeing back into the Turkish debt market after severe turmoil at the start of the year, but many remain deeply skeptical about the prospects for one of the world’s largest emerging markets.

A $ 2.25 billion Turkish dollar bond sale this week has drawn strong demand from investors in the UK, US and Europe, in the latest sign of how the country is starting to attract fund managers with high returns that are elusive in many other markets.

“Some investors are prepared to stick their noses up despite all the risks,” said Timothy Ash of BlueBay Asset Management. “We have had a few months of relative monetary stability, the carry is high, we are in a low yield world.”

Some fund managers have had no choice but to go back. During the months of relative stability, Turkish assets made a positive contribution to emerging market asset returns overall. This means that fund managers who invested less in Turkey than its weight in their benchmarks underperformed.

Those who have actively shorted Turkish currency or Turkish bonds – borrowing them and selling them in the hope that the price will drop and they can buy them back cheaply and pocket the difference – have seen these trades go wrong. sense.

“Turkey is a painful business,” said Ray Jian, portfolio manager at Amundi, Europe’s largest asset manager. “Everyone is underweight or short and pays negative carry over and no one is making any money.”

The allure of high yields has also been too strong for some investors to ignore. A 12-year bond, denominated in US dollars, which was sold as part of this week’s debt deal will be issued at a yield of 6.5%, higher than the yield of around 5% offered in the market. emerging market government bonds, according to a JPMorgan Debt Index.

Turkish lira-denominated debt offers even juicier yields, with the benchmark 10-year government bond paying 16%. Some traders participating in the “carry trade”, in which they borrow in the currencies of relatively low yielding countries such as the dollar or the euro and then lend in areas with higher interest rates, were also attracted.

Global bond yields are near all-time lows, with 10-year US Treasuries yielding 1.3% and many highly rated European bonds priced such that investors are assured of a loss if they keep them until they expire.

As sentiment around Turkey has improved in recent months, many investors say they remain reluctant to inject more capital into the country after a series of interventions earlier this year by Recep Tayyip Erdogan’s government. brought down asset markets and severely eroded investor confidence.

Investors sharply reduced their positions after Erdogan sacked Naci Agbal in March, appointed the fourth central bank governor in five years last November, just 36 hours after raising interest rates.

Sahap Kavcioglu, his little-known replacement, was to cut interest rates at the earliest opportunity. He was named by Erdogan, who sees high rates as the cause rather than the cure for high inflation in Turkey, as well as “the mother and father of all evil”.

The pound fell 14% to an all-time high in response to Agbal’s layoff and remains down nearly 12% for the year to date. Markets stabilized this spring, helped by Kavcioglu’s refusal to cut interest rates from the 19% level set by Agbal.

However, the damage from this latest Erdogan intervention, coupled with other moves in recent years that have worried investors, has already been done.

International investors hold around 4% of the country’s local government bonds, according to data collected by the Institute for International Finance. In 2013, when they were most optimistic about Turkey’s growth, foreign investors held almost a quarter of public debt in local currency.

It wasn’t just Erdogan’s views on monetary policy that turned investors away. Geopolitics and Turkey’s role in an unstable region have also contributed. Erdogan’s willingness to get closer to Russian President Vladimir Putin has been a concern.

But analysts say those concerns have eased since Erdogan met US President Joe Biden at the NATO summit in June – another reason for fund managers to reduce their underweight positions.

Another persistent cause of concern is Turkey’s current account deficit and how to finance it. The account briefly went into surplus in 2019 before reverting to a deep deficit during the pandemic. But from January to July of this year, the deficit narrowed to $ 13.7 billion from $ 23.2 billion during the same period in 2020, according to the central bank, largely due to a better-than-expected recovery in tourism revenues.

Meanwhile, inflation rises above 19 percent, which means Turkey’s very high policy rate is negative when accounting for domestic price growth.

For investors, said Atilla Yesilada, analyst at Istanbul-based GlobalSource Partners, “there is always a trust issue.”

“You don’t know what will happen in Turkey tomorrow,” he added.

Additional reporting by Ayla Jean Yackley in Istanbul