01 November, 2015

Cold Turkey??

The Turkish economy has faced a number of headwinds during 2015, Mena Fund Manager looks at the health of the Turkish market and asset management industry.After an impressive 2014, in which it was one of the region's best performers, the Turkish market has struggled this year. The S&P Turkey BMI index has fallen by -30.7% so far in 2015, as political uncertainty takes its toll on the country. Last

The Turkish economy has faced a number of headwinds during 2015, Mena Fund Manager looks at the health of the Turkish market and asset management industry.
After an impressive 2014, in which it was one of the region's best performers, the Turkish market has struggled this year. The S&P Turkey BMI index has fallen by -30.7% so far in 2015, as political uncertainty takes its toll on the country. Last year, the index rose by 16.8%.

While hosting more than 1.9 million Syrian refugees, Turkey has also experienced much political uncertainty in 2015, as elections earlier in the year resulted in a hung parliament. Fresh elections were called after coalition talks failed after the ruling Justice and Development Party (AKP) failed to return a majority for the first time since 2002. A crackdown on the Kurdish group PKK and its joining of the US-led coalition against Islamic State has added to uncertainty. Action against the PKK group has sparked acts of retaliation and unrest across the country. Noting the political situation, the IMF revised its GDP growth estimates for Turkey downwards in October. The growth outlook for Turkey was revised from 3.1% in April to 3.0% for 2015 and from 3.6% to 2.9% for 2016. The prospect of an interest rate hike in the US has exacerbated concerns about the Turkish economy, as many economists forecast further difficulties.

Even small victories have been worth celebrating. While the Turkish economy has showed signs of slowing in recent months with PMI readings hovering below 50.0 - signalling declining orders for manufacturers - during much of 2015, analysts have found grounds for optimism.

"Turkey's manufacturing sector remained in a downturn in September, with new orders and output both falling at faster rates and firms cutting back on purchases," noted Trevor Balchin, senior economist at Markit.

"That said, the PMI average for the third quarter as a whole was slightly higher than in both the first and second quarters of the year. The latest survey again highlighted growing inflationary pressures linked to the weak lira, but on the flipside the currency was reported to have boosted exports during the month."

Turkey in trouble?

Sentiment towards Turkey has changed over the past few years as questions have been raised over the perceived political stability.

"Since June 2013, Turkish equity market has been in a downward trend on a US dollar basis, parallel to other emerging markets," notes Yigit Onat, CIO & head of equities at HSBC Asset Management Turkey. "The street protests against the government coincided with Fed's tapering concerns during the summer of 2013 resulting in a heavy sell-off for Turkish equities."

He adds: "In 2014, Turkish equity market outperformed emerging market peers by 23% on the back of perceived political stabilisation and lower energy prices.

"The ruling AKP landslide victory in local elections in March and its leader Erdogan's successful bid in the presidential elections in June 2015 reassured investors' perception towards Turkish politics."

However, Onat says intervention by the government in the Turkish central bank's monetary policy had triggered negative sentiment from investors at the start of the year, while June's election results caused further uncertainty.

As well as political uncertainty, a number of challenges has hampered Turkish corporate performance in 2015, slowing growth prospects, currency weakness, weak consumer confidence, weak export markets, and political uncertainty, says Onat.

He adds: "Rising stagflationary risks requires implementation of structural reforms and a new economic model."

Yet, while the outlook may have turned more negative in recent months, some managers remained convinced of the opportunity in markets and the emergence of positive signs for investors considering Turkey.

"The Turkish equity market has already discounted political uncertainty scenarios to a large degree as the main equity index has retreated by 31% in US dollar terms and underperformed the MSCI Emerging Markets Index by 19% through September," says Onat.

"We've reached a point where the negatives in Turkey have now been accurately priced in and even small adjustments would be ample justification to drive stock prices higher," says Matthias Siller, EMEA equity investment manager at London-based Baring Asset Management.

Yet, as the S&P performance suggests, there have been some challenges for Turkish companies over the past year. HSBC's Onat says sectors that have underperformed include the telecoms and aviation sectors.

The banking sector has also been hit by concerns over asset quality, which has impacted on performance. With financials representing almost 40% of the S&P Turkey BMI Index, the banking sector can weigh on the performance.

Capital Economics senior emerging markets economist Will Jackson claimed the banking sector remains vulnerable to a rise in bad debts and slowdown in lending as the Turkish lira weakens and interest rates are raised.

Despite poor performance in 2015, so far, Onat says the outlook for the banking sector is not as poor as some may suggest. "We have a constructive outlook for Turkish banks despite regulatory pressures. We believe the current profitability challenges of the system will not go away in the immediate future but the prospects will improve as the impact of the upward loan re-pricing kicks in towards the end of 2015."

He adds: "Bad loan formation continues to be benign, and banks have more room for improvement on the operating expenses, which together mean we may not see much drag below the net interest income line."

Outperforming sectors during 2015, meanwhile, have included the chemicals and petroleum, insurance, real estate investment trusts, automotive and consumer goods sectors.

"While we have been bullish on refinery, oil and gas distribution, aviation and retail sectors, we have been bearish on iron and steel, automotive, glass and telecom sectors," adds Onat.

Asset management outlook

While stock pickers and allocators might be bullish about the prospects for the market and the Turkish economy, the asset management sector has seen some declines.

There were 100 fewer Turkish mutual funds at the end of the first half compared with 2014, while the portfolio value of the industry was slightly lower dropping to TRY32.8bn ($11.4bn), according to data from the Capital Markets Board of Turkey (CMB).

Turkish portfolio management companies oversee $33.9bn on behalf of investors, down from $35.1bn at the end of last year but the second highest year since records began.

The CMB remains optimistic for the funds industry, which was boosted by the launch of the Turkish Electronic Fund Distribution Platform (TEFAS) at the start of the year, fund supermarket enabling investors to access products through a single investment account.

One of the bright spots for the Turkish asset management industry has been the private pension space.

Its private pension funds sector has continued to grow over the years since it was established in 2003. With a 25% state contribution granted to savers, the popularity of private pension funds has soared. There were more than 5.5 million pension fund participants spread across 248 pension funds with a value of $15.8bn at the end of June, according to the CMB.

"I haven't seen many similar things in the Mena region nor have I seen many successful long-term developments in emerging Europe.

"Having a scheme in place that tries to incorporate the second pillar [of pensions] into every Turk's long-term pension basket is extremely positive. I can't say how positive it is given how many negative developments I've seen in other countries," says Baring's Siller.

"It's typical Turkey gets all the negative headlines but not the appropriate praise for positive implementation of helpful and long-term strategies.

"The Turkish government, especially the Ministry of Finance, has truly done the right thing and it came up against some powerful opposition."

Elsewhere, the Borsa Istanbul has set up a number of initiatives signing a number of memoranda of understanding with stock exchanges in the region and further afield. It began offering derivative contracts for the BIST 30 Index via the London Stock Exchange, part of a broader effort to build out its derivatives trading activities.

Looking ahead

There may be few new opportunities for investors as listing activity dries up in the near term. In the year through 1 June, there were just three IPOs, compared with nine in 2014. According to the Borsa Istanbul, there is just one IPO currently under consideration.

"The IPO environment also depends on the restoration of political stability and improved sentiment towards emerging market assets," says HSBC Turkey's Onat. "We don't expect big ticket IPOs until second half of 2016."

One of the biggest challenges for Turkey is the impact of foreign investor outflows. Investment bank Morgan Stanley included Turkey in its 'fragile five' group of emerging market countries facing economic challenges. The group - which also includes Brazil, Indonesia, South Africa and India - represents economies more sensitive to foreign investor flows.

Indeed, prior to June's general election, questions had been raised over the independence of the Turkish central bank prompting some investors to pull out of the market. However, outflows from emerging markets have accelerated in recent months.

"Capital flows to emerging markets have weakened markedly this year, after a substantial decline in 2014," noted the Institute of International Finance. "We estimate that net non-resident inflows will reach only $548bn in 2015 down from $1.1trn last year, sinking below levels recorded in 2008/09."

Outflows were one of the main risks warned by the IMF in its most recent consultation with Turkish authorities, noting the potential impact of any rise

"Shocks to market expectations about monetary policy normalisation in advanced economies or changes in expectations about emerging economies' growth prospects could result in a reduction of capital inflows or even a sudden stop," it noted last December.

Capital outflows could have a significant impact on the Turkish market, yet fund managers remain bullish on valuations and fundamentals which could see some foreign investors may be tempted back once the political environment stabilises.

"I don't agree with the 'fragile five' thesis since it simplifies the very complex economic structure of those five countries and, in Turkey's case, it denigrates the very real strengths of the economy," explains Mark Mobius, executive chairman of Templeton Emerging Markets Group. "There are still many investment opportunities in Turkey, especially in the consumer area.

"Turkey is a very vibrant economy with a well-trained and educated workforce and excellent managements capable of entering global markets effectively. Therefore we cannot say that it is 'fragile'."

Indeed, the outlook for the economy seems less bleak than some have forecast. Supported by a young population growing domestic demand and low oil prices, the energy importer should see growth that certainly outstrips a number of developed markets. Some managers have forecast Turkish firms could also benefit from the opening up of the Iranian market, once sanctions are lifted, with demand for a number of services as trade normalises between the two.

"The domestic economy is holding up quite well," says Siller. "You have a situation where Turkey has performed much better than what many people had feared, especially compared to emerging markets like China.

"Turkey is standing out in regards to the resilience of domestic demand. If you look in detail, there's no reason to believe this natural rate of growth will taper off any time soon.

"The components of the underlying demand within the domestic economy seem to be more medium-to-long term than in other emerging markets.

"Turkey is no longer another emerging market you could forget if you wanted to. It has some inherent characteristics that could make it stand out from the global emerging market crowd in the next couple of years."

Siller adds that Turkish equities "absolutely" have a role to play in global emerging markets and Mena investment portfolios going forward.

Whether international investors flock back to Turkey will depend on a return to stability. All eyes will be focused on the government's next move after Turks return from the polls, searching for positive signs.

© MENA Fund Manager 2015

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