Turkey has twin deficits, the fastest inflation in almost five years and is at risk of being dragged into another conflict in the Middle East. But Japan’s intrepid retail investors will forgive a lot when it comes to yield.
It’s those 10 percent-plus rates across the Turkish bond curve — among the highest in major emerging markets — that are luring Mr. and Mrs. Watanabe to the country’s assets.
Starved for return by near-zero rates at home, individual investors have propelled a 27 percent jump in Japanese mutual funds’ investments in lira-denominated bonds this year. At 50.8 billion yen ($450 million) through August, it’s poised to be the biggest annual increase since 2012, according to data from Japan’s Investment Trusts Association.
“Political risks are still there and the economy remains sluggish while inflation remains high — but those negative factors have already been priced in the markets,” said Takeshi Yokouchi, a senior fund manager at Daiwa SB Investments Ltd. in Tokyo, which manages the equivalent of about $51 billion in assets. “There may be more upside than downside and their higher yield levels are definitely positive from the carry perspective,” said Yokouchi, who recently went “slightly” overweight on Turkey’s lira.
He’s not the only one — foreign investors have pumped $6.96 billion into Turkey’s local currency bond market this year, the most for the period since 2012. That’s despite the lira putting in the third-worst performance versus the yen among major emerging-market currencies in 2017 through the end of September. The nation faces other challenges too, with a push for independence by Kurds in Iraq elevating tensions in the region, and Turkey’s above-target price growth keeping pressure on the central bank to keep monetary policy tight.
While that’s negative for issuers, it makes Turkish debt “very popular among Japanese retail investors given how it has kept a relatively high yield,” Hideo Shimomura, chief fund manager at Mitsubishi UFJ Kokusai Asset Management Co., which oversees the equivalent of $112 billion in Tokyo. “Turkey seems to have more upside than the downside after selloffs last year.”
After being hit by Fitch Ratings cutting Turkey to junk, and the currency’s subsequent slide, sales of lira-denominated Uridashi bonds, targeted at Japanese investors, are well in recovery mode. They’ve already more than doubled this year to $1.1 billion, and at almost 5 percent, lira debt make up the biggest chunk of emerging-market Uridashis, data compiled by Bloomberg show.
But it’s the lira’s underperformance that could ultimately weaken Japanese demand for Turkish debt.
The currency slipped to a 2 1/2-month low last week against the dollar as the Federal Reserve left the door open for an interest-rate hike in December. Turkey’s reliance on foreign inflows to finance one of the widest current-account deficits as a percentage of output among the Group-of-20 nations nations leaves the lira largely at the mercy of foreign investor sentiment.
If Turkey’s trade balance and the carry offered on the currency “aren’t going to get better,” the rally that helped the lira recover from a record low could falter, said Manik Narain, an emerging market strategist at UBS Group AG in London.
The country’s 10-year bonds yielding “closer to 11 percent would help,” he said. They currently yield about 11 percent, which is still well above similarly rated Russia at 7.6 percent, but below Argentina’s nearly 14 percent yield, the highest among emerging markets after Venezuela.
But for some Japanese investors, most of the negatives around Turkey have already been priced in to the lira. Growth prospects aren’t looking all that bad, either.
Tokyo-based Asset Management One Co., which oversees the equivalent of about $480 billion, keeps an overweight position on the currency, while its holdings are mainly in short-term bonds because of the yield, says Akira Takei, a fund manager at the company.
“It’s the carry that is quite attractive despite some underlying risks,” he said. “As long as the lira is relatively stable versus the yen, it’s OK.”