Turkish Delights: A Deep Bond Market Bursting with Opportunity

Turkish investment opportunities are among the broadest within emerging markets (EM) debt and can be fully captured through a flexible approach to EM debt. We continue to favor Turkish corporates, many of which are blue chip companies with significant geographic diversification of revenues, or ample pricing power, run by some of the strongest corporate management teams in EM. Amid cautious optimism on Turkey’s improved macroeconomic policymaking, we have turned more positive on local currency and hard currency sovereign debt. On the latter, while valuations appear somewhat full, we favor the higher yield and scope for upward credit trajectory versus peers.

Renfrew Reminisces Turkey’s past and Nuveen’s views on its future

One of my earliest trips to Turkey was in 1999 to conduct due diligence on an automobile manufacturing facility owned by Ford Otosan, a joint venture between Ford and the behemoth Turkish conglomerate, Koc Holding. This was one of several Turkish private placement credit deals in which Nuveen’s parent company, TIAA, had invested at the time. Since then, the team and I have returned time and again to a country that has been forever resilient in the face of natural disasters, global financial crises, coup attempts and geopolitical risks. Resilience is driven by the government’s relatively sound fiscal starting point and a dynamic private sector borne from a deep trading culture given Turkey’s location at the nexus of Europe, Asia and the Middle East.

More recently, Turkey has faced growing economic imbalances, largely due to unorthodox policymaking and institutional erosion amid a political imperative to pursue growth at all costs.  While we have seen backtracking in the direction of more sensible policymaking at different points over the last decade, the degree of macro mismanagement accelerated in 2022 and culminated in first half of 2023, when financial stability risks reached a fever pitch on the back of runaway inflation, ultra loose monetary policy and a deteriorating fiscal position.

Fortunately, the Turkish market offers a diverse menu of investment opportunities across hard currency (USD or EUR) sovereign bonds, corporates, local currency debt and structured finance instruments, which we have flexibly utilized to manage through periods of market volatility. We have held a varied composition to Turkey for most of the past decade, preferring corporates and banks over sovereign and state-owned entities. We reduced exposure in 2019 as valuations sharply recovered from the mid-2018 currency-crisis, then leaned back into Turkish corporates and banks, selectively, in 2020-21 as market volatility and new issuance created interesting relative value opportunities. We dynamically pulled back again in 2022-23 amid concerns regarding the policy outlook, coupled with uncompelling valuations and expectations that supply (both sovereign and corporate) was likely to increase significantly.

Looking ahead, we are cautiously optimistic on Turkey’s macroeconomic outlook given the appointment of a credible economic team led by Mehmet Simsek last summer. Since then, we’ve seen substantial tightening of monetary policy, a rollback of distortionary banking rules, and an announced commitment to fiscal tightening. Importantly, this improved policy mix seems set to continue even after the ruling party suffered an unexpected defeat in local elections last month. However, sharp policy reversals are not unprecedented and the institutional framework for decision-making still rests heavily with one individual, President Erdogan. These factors keep us disciplined in ensuring we are adequately compensated for potential downside risks.

Policy orthodoxy is key to work out imbalances and to create a virtuous cycle for Turkish assets…

Following municipal elections in late-March, Turkish policymakers’ current focus is on the economy. We were encouraged by the Central Bank of Turkey’s (CBRT) response to inflationary pressures with a strong and unexpected pre-elections policy rate hike. This was after already tightening at a significant clip since last summer. The authorities also announced additional measures to reduce credit extension. These moves should temper concerns about the central bank’s commitment to bringing down inflation and driving stronger local and foreign investor confidence in Turkish Lira (TRY) assets.  That said, the ruling party’s defeat in the local elections might invoke some political constraints on the economic team and the CBRT with respect to the degree of tightening space and timing to achieve results.

We also continue to monitor Turkey’s balance of payments. FX reserves came under significant pressure in early 2024 as Turks became concerned about devaluation post elections. We’ve seen improvement since March, which we attribute to some de-dollarization given the rate hike and policy continuity, and are cautiously optimistic about the external position going into the seasonally stronger summer period, with the tourism season kicking off in April.

…But politics is everything

Achieving a lasting disinflation trajectory in Turkey is dependent on political backing for policymakers. While macroeconomic management has become more sound over the past nine months, resulting in credit rating and/or outlook upgrades for Turkey, the institutional framework driving decision-making has not changed, as the concentration of power in President Erdogan remains high. Encouragingly, Erdogan, even after his party’s losses, sounds committed to providing support to the more orthodox policy approach under Mr. Simsek. Geopolitical relationships have also been improving as Erdogan makes rapprochements with the US, Saudi Arabia, Sweden, Greece and the EU after a much more difficult period. The question remains, however, as to whether these are durable, or turn out to be purely transactional relationships.

Warming on local bonds, while constructive on hard currency sovereign debt on higher yield and improving fundamentals

We have been cautious on Turkish lira denominated assets for a long time, exiting completely in April 2018, just prior to the significant Turkish lira devaluation. We tactically re-entered local government debt in 2020 but have largely been uninvested over the last five years. However, as we’ve seen policy orthodoxy continue, our conviction has increased resulting in gradually reentering local currency government debt as local yields sufficiently compensate for the currency weakening trend. We await further progress and conviction on disinflation before adding.

We have also been measured in adding Turkish hard currency sovereign bonds as spreads have compressed by nearly 40% since early June 2023. That said, we do like the higher yielding profile and the potential for upward credit momentum.

Selectivity remains critical in Turkish corporates

Given Nuveen's 25+ years’ experience with Turkish corporates, we recognize that the complex offers compelling opportunities when compared to investing in sovereigns alone. By and large, Turkish companies that issue debt in global debt markets are blue chip companies, with significant geographic diversification of revenues or, with strong pricing power domestically. One example is Ulker, a chocolate and biscuit company that generates 35% of its revenue outside Turkey while also maintaining a strong domestic market share. While Ulker bonds declined after their debut issuance amid Turkish market volatility and refinancing concerns, we elected to hold given comfort with the company’s strong brand equity, market positioning, and improving financial management.  Last year, the company successfully refinanced its maturing loans, and we expect a bond refinancing this year. We are seeing select opportunities to add Turkish corporates, particularly given the attractive relative value in new issuance.  At present, we are more sanguine on Turkish bank paper, where valuations look less compelling.

Turkish corporate bond issuers typically have low leverage and strong liquidity management versus global peers. Several firms have higher credit ratings than the sovereign, in some cases by several notches. At various points in the cycle these positions can contribute meaningfully to performance, particularly in risk-off environments.  While Turkish banks have been vulnerable to deterioration in the macro policy, maintenance of strong capital and liquidity buffers, along with proactive risk management, has enabled them to weather volatility.