U.S. Bond Investors Forgive Turkey Risks in Search of Yields

Updated on
  • Inflows to local bonds picked up in August: central bank data
  • Inflation, political turmoil key risks for Schroder’s Brown

Military uprising, war across the border and the threat of a credit downgrade are not deterring investors from Turkey’s bonds, with U.S. money managers Eaton Vance Corp. and Newfleet Asset Management LLC among those sticking to or raising bets.

More than $4 billion has flowed into the nation’s local-currency bonds this year, with $638 million arriving since the botched coup in July and most of that in the week ending Aug. 26, according to the latest central bank data. Net inflows to bond funds investing in lira and dollar-denominated Turkish securities were $281 million in August, according to data compiled by EPFR Global.

Turkish debt’s main draw is its yield, with 10-year notes paying out more than six times their U.S. equivalents. That’s helping investors look past risks such as the possibility Moody’s Investors Service will cut the country to junk status later this year, a move that may trigger billions of dollars in forced selling by funds not permitted to hold speculative-grade assets.

"We were underweight heading into the coup and added some exposure in the aftermath on cheaper valuations," said Steve Hooker, a money manager at Hartford-based Newfleet which oversees $11.5 billion. "We are holding off for the moment at these levels until we see the outcome of the Moody’s credit review. However, if valuations cheapen a lot in advance of the conclusion of that review I will probably add a bit more.” Hooker said the majority of Newfleet’s Turkish holdings are dollar-denominated bonds.

Yields on 10-year lira notes jumped 116 basis points in four days after the coup, and have since dropped 64 basis points to 9.61 percent on Tuesday, data compiled by Bloomberg show. That’s the highest rate after similar-maturity, local-currency debt for Brazil, which offers 12 percent.

Turkish assets tumbled in the week after the coup attempt as S&P Global Ratings downgraded the country’s credit and Moody’s warned it may follow suit, citing potential for the political turmoil to impact growth and policy making. The nation’s bonds lost 4.2 percent in the period, the worst performance among more than 80 countries in the Bloomberg Barclays EM USD Aggregate bond index.

Cutting Rates

The central bank has cut its overnight lending rate twice since mid-July, bringing total reductions this year to 225 basis points, even as inflation remains above target. That easing policy is helping underpin the bond market, according to Michael Cirami, a Boston-based money manager at Eaton Vance.

"The cost of this will be a weaker currency but there’s still enough yield on the bond to have spreads come down a bit from where they are now,” he said.

Still, the central bank’s push to lower borrowing costs is among reasons to stay away, according to Nick Brown at Schroders Plc. He attributes much of the inflow to Turkish bonds to a broader shift toward emerging markets by money managers seeking antidotes to the near-zero yields on developed-world assets. Many investors track benchmarks that include Turkey so an increased bet on developing nations would automatically include an allocation to the country.

“A rising tide lifts all boats and that includes Turkey,” said Brown, a money manager who helps oversee $3.9 billion in emerging-market debt at Schroders in London. “When you look at Turkish assets they look fairly valued. If you add in the political mix, then they start to look expensive.”

Downgrade Risk

Political risk is what puts Moody’s Baa3 rating for Turkey, its lowest investment grade, in the balance. Any reduction in status would be the second junk score after S&P’s BB. That may trigger as much as $8.7 billion in forced selling by investment-grade funds, according to JPMorgan Chase & Co.

“I have been surprised by how quickly we unwound whatever risk premium was priced in after the coup,” said Kamakshya Trivedi, Goldman Sachs Group Inc.’s chief emerging-market strategist in London. “I can see why, given the yield it has and if you don’t think a downgrade is very likely, the bonds might be a good carry trade as well. But it’s one of the places we dislike.”

Turkey has returned 2.9 percent in the past month to investors who borrowed in dollars and bought the country’s currency. That’s the second-best performance among major emerging markets tracked by Bloomberg.

"At various times, value opens up and the coup attempt led to one of those where some value came into the equation," said Cirami at Eaton Vance.