Vanguard says Erdogan loss would make Turkey bonds loved again

One of the world’s biggest investors sees lots of potential in Turkey’s long-shunned bond market — if only President Recep Tayyip Erdogan loses an election for the first time in 20 years.

Vanguard Group Inc. has been closing some of its underweight positions on Turkey in the run-up to presidential elections in May, said Nick Eisinger, co-head of emerging-market active fixed income at the US fund, which manages about $7.1 trillion in assets.

That puts the firm among investors positioning for the chance that Erdogan’s increasingly unpredictable rein over the $820 billion economy might be nearing an end. Offshore investors deterred by erratic policymaking have pulled more than $60 billion from the bond and equity markets in the past five years, while cutting holdings of lira-denominated assets to the lowest level on record.

“Turkish bonds could be a very profitable trade if Erdogan loses, Eisinger told Bloomberg in an interview from London. “If Erdogan wins, he will likely carry on with the same unorthodox policies on interest rates and credit extension and it’s likely the external funding gap would remain large.

Guided by Erdogan’s unorthodox belief that high interest rates fuel inflation — although economic textbooks say the opposite is true — Turkey’s central bank has kept interest rates artificially low since 2018. The side effects of that policy, which have included soaring inflation, a weak currency and dwindling appeal for lira-denominated instruments, have sent foreigners running.

Foreign holdings of local debt fell from $72 billion in 2013 to $1.4 billion this month, according to data from the central bank. International money managers account for about 35 percent of the ownership of Turkish hard-currency sovereign debt, down from more than 50 percent in January 2021.

Turkey’s total debt market is worth about $320 billion, of which about half is in foreign currencies, according to data compiled by Bloomberg.

Unified Opposition

Earlier this week, a diverse group of opposition parties, calling themselves the “Table of Six, finally announced Kemal Kilicdaroglu, the leader of main opposition party CHP, as their joint candidate to face Erdogan in May. The 74-year-old says his government would quickly undo Erdogan’s policies, return independence to the central bank, and take a more market-friendly approach to the country’s deepening economic problems.

Opinion polls suggest this could be Erdogan’s toughest election yet, with less than half of the electorate saying it’d vote for his ruling AK Party or its nationalist allies. No reliable polls have been published since Kilicdaroglu was selected as the opposition joint candidate.

Bond Rally

Turkey’s dollar bonds have outperformed peers so far this year, with its longest-dated debt gaining 3.6 percent. That compares with a 0.4 percent gain for a Bloomberg index of emerging-market sovereign bonds. Vanguard’s emerging-market debt fund is up 1.2 percent in 2023 and 17 percent over the past five years, outperforming 99 percent of peers, according to data compiled by Bloomberg.

Eisinger says he’d also look at lira-denominated bonds in the event of an opposition victory, as it’d be likely that the lira would be allowed to depreciate. Turkish officials have kept the currency under close wraps for the past six months, ensuring a gradual depreciation that many investors say has left it highly overvalued.

“Credit is one of the better trades in the event of an Erdogan loss, Eisinger said, referring to sovereign debt. “That is because the FX would probably have to weaken under a new administration.

Laurence Bensafi, a money manager at RBC Global Asset Management, says the same could be true of the stock market.

“If we were to see the polling results showing the opposition leading, some foreign investors will come back, she said. “There is a lot of interest right now, but still the uncertainty is high, and investors are performing their due diligence in order to pull the trigger quickly if and when the moment comes.