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Beware of over-reacting to Turkish coup attempt

18-07-2016 | Insight | Wim-Hein Pals, Paul Murray-John Investors should not over-react to the attempted Turkish coup as normality returns, say Robeco’s experts on investing in the country.

Speed read:
  • Attempted coup by Turkish army leaves hundreds dead or injured
  • Turkish equities, bonds and the lira all fall as trading resumes
  • Overweight to stocks was reduced but bond holdings rise
A military force tried but failed to overthrow the government of President Recep Tayyip Erdoğan on Friday 15 July, leaving an estimated 290 people dead and 1,000 injured. Once the coup fizzled out, the Turkish government reasserted itself and arrested over 6,000 alleged plotters. It was the sixth coup or coup attempt in Turkey since 1960.

Turkish stocks fell 2.5% when trading resumed on Monday 18 July, while the lira dropped 1% in value and Turkish government bond yields rose as their prices fell. The country is rated BB+ by Standard and Poor’s, which is below investment grade. The fall in asset prices was relatively mild, especially when compared to market reaction following the Brexit vote.

Robeco had earlier this year reduced its overweight to Turkish stocks in its core Emerging Markets Equities fund, while the Emerging Debt fund has taken advantage of lower bond prices to add to the portfolio, believing that the political risk is now priced in.

“President Erdogan and the government are still in power, but the political situation has further deteriorated,” says Wim-Hein Pals, head of the Robeco Emerging Markets team. “The power of the president will most likely increase further after the event, which is not necessarily a positive development for the long-term future of the country.”

Downgraded stance

“Earlier this year we downgraded our stance with regards to the Turkish political situation, in part because of a wave of militant violence. As a consequence, we lowered the overweight portfolio position in Turkish equities in our core Emerging Markets strategy. Turkey’s political climate could become more oppressive and authoritarian, which would cause an increased level of caution towards Turkish equities in our clients’ portfolios.”

“Over the weekend the Turkish government moved swiftly to calm investors, with the central bank promising unlimited liquidity to the banks, and the deputy prime minister Mehmet Simsek reaching out to international investors by assuring them that Turkey is normalizing rapidly after the coup attempt was repelled by the nation. The country’s macroeconomic foundations are solid.”

Pals says Turkey remains a bright spot for investors given its high growth rate when compared with stagnating growth in developed markets. “In a global low growth environment, Turkey’s gross domestic product has beaten estimates since the fourth quarter of 2014, thanks to rising household spending. The economy grew 4.8 percent in the first quarter of this year,” he says.

‘Turkey’s gross domestic product has beaten estimates’

“The political situation in the country has become even more challenging of course, but that said, businesses in the country could continue to do relatively well with the exception of sectors that are exposed to tourism and leisure. We are not invested in these sectors and we prefer stocks in Turkey with a superior earnings profile and attractive valuation parameters.”

“One of the arguments for investing in Turkey are the low valuations, which have always priced in at least some political risk. Some banks are trading at four times earnings and 0.5 times book value. A well-managed oil refinery and distribution company trades at seven times earnings.”

Close monitoring

Just before the coup started, Robeco’s Emerging Equities mainstream strategies had invested 1.5% in Turkey, against a 1.2% weighting for the country in the MSCI Emerging Markets Index. Robeco’s Emerging Markets high conviction strategies have a 4% portfolio weight.

“In the coming days and weeks we will closely monitor the effects of the failed coup on the earnings of our portfolio holdings. In the short term we expect volatility in the equity and currency markets, but given the prompt response of the government so far we do foresee stability coming back after the initial correction, at least for the medium term,” says Pals.

He says the future level of economic and political risk will depend on three things: the scale of foreign outflows, which is something to monitor closely given the need for external financing; the chance of a credit rating downgrade; and the future political landscape.

“All in all, there are ample reasons for us to remain cautious and critically review the portfolio positions in the very near future,” says Pals. “In the short term however, trading in panic never does serve the interests of our clients.”

Role of Turkish military

As regards the coup itself, investors should understand the role that the military has played in Turkish history and society, says Paul Murray-John, manager of the Robeco Emerging Debt fund which owns Turkish government bonds. “We need to assess Turkey rather differently in this case when compared to other European countries,” he says.

“The Turkish army sees itself, and is seen by Turkish society, as a force for political modernization and as a guardian of liberal democracy. This role has been played most obviously, and surprisingly regularly, through direct intervention on the streets. Military intervention in the past has been to either suppress political violence or to buttress the democratic process. So it can be of little surprise that President Erdogan's increasingly anti-democratic behavior produced a reaction from the army.”

‘The outlook for emerging market fixed income securities remains reasonably stronger’

His fund has been underweight or neutral to Turkey in recent months, but added to its government debt holdings on Monday. “The market reaction this morning has been to immediately reprice the Turkish lira lower and bond yields higher, to reflect the increased political risks,” he says. “However, the overall outlook for emerging market fixed income securities remains reasonably stronger, as the global factors of steady Chinese growth and extremely low interest rates and yields in developed economies encourage a reach for yield by investors into emerging bond markets.”

“Although we continue to have concerns about the medium to long-term direction of Turkish politics, particularly President Erdogan's plans for changing the constitution, we view the short-term repricing of assets as an opportunity to take some additional risk in the local bond market, and have added a small long position in the Emerging Debt fund relative to its index. We will remain particularly focused on the country and continue to review the political and economic situation as it develops.”
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