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

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

Foreign ownership of the securities has risen in eight out of the 10 weeks since Naci Agbal took the helm as governor of the central bank in November, with weekly flows on Dec. 18 hitting the strongest level since 2017. The trend underscores how firms including Pacific Investment Management Co., Amundi and UBS Asset Management are betting on a lucrative year ahead for Turkish bonds as recent interest-rate increases put the shackles on inflation and credit growth.

The turnaround comes after a period of continuous unloading of the debt. Foreign ownership of bonds tumbled to an all-time low of 3.3% in November, compared with about 20% in September 2018, according to Deutsche Bank AG. It also marks a change from 2020, when the lira weakened for an eighth straight year and local bonds lost 13% as President Recep Tayyip Erdogan ruffled investors by calling for looser monetary policy even as inflation was accelerating.

Investors are betting that Erdogan, though still in favor of lower rates, will nevertheless let his new economic management team steer policy without interference. Governor Agbal has pledged to follow a more orthodox monetary approach, and hiked the policy rate twice last year to 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 past 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 have added $3.1 billion worth of Turkish lira bonds to their holdings since November, according to central bank data. The purchases raised the share of foreign holdings of Turkish domestic debt to 4.4%. That’s still low in global terms. Non-residents own 24% of Russian bonds, 30% of South Africa’s and 48% of Mexico’s.

Amundi and UBS have also raised Turkey to “overweight” in their emerging-market debt allocations. Vanguard Asset Management, whose emerging-market 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 this month 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. The lira has gained 0.8% this month -- the best performance among emerging markets after the Chinese currency.

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 policy makers keep interest rates so 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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