How to Invest in a Powerhouse Emerging Market

Turkey’s stock market, dominated by a highly-regarded banking sector and flourishing consumer goods industry, is easy for foreign investors to access.

Traders work on the floor of the Istanbul Stock Exchange in Istanbul, Turkey.
Bloomberg | Getty Images
Traders work on the floor of the Istanbul Stock Exchange in Istanbul, Turkey.

Try exchange-traded funds and mutual funds. The money is flowing in, and Turkey-based indexes are outperforming.

Government-controlled industries, led by the sizzling energy sector, present growth opportunities for foreign direct investors who are expected to inject some $15 billion to $20 billion into the economy this year. Major Persian Gulf investors are pouncing on Turkey’s rapidly expanding real estate market, which has become a haven for western European retirees. Meanwhile, more Gulf sovereign wealth funds, investment funds, and private equity funds are turning to Turkey to avoid Europe’s worsening debt crisis.

ETFsoffer some diversification, but banks rule the Turkish equity market. Financials comprise 48 percent of the iShares MSCI Turkey Investable Market ETF’s holdings, followed by consumer staples and industrials, which accounting for the second- and third-largest sectors. Turkiye Garanti Bankasi, the nation’s largest lender by market value, carries 13 percent of the fund.

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Turkey’s banking sector jumped 11.4 percent from a year ago to 11.55 billion lira ($6.49 billion), for the first six months of 2012. The iShares MSCI Turkey Investable Market is outperforming the rest of the world, ballooning 27 percent so far this year. That's a major rebound from last year’s dismal performance, a negative 36.3 percent return.

“Certainly using the ETF is very efficient, because you get the whole Turkish market,” said Russ Koesterich, global chief investment strategist for BlackRock's iShares ETF business.

Beyond its banking system, the modernization of Turkey’s trading, clearing, custody and depository services “will further facilitate the adoption of Turkey within the more established investment funds and should help increase stock velocity and the use of derivatives instruments to hedge risk,” said Philippe Carré, of global head of connectivity, SunGard’s global trading business.

The success of some of the Turkish blue chips on the Istanbul Stock Exchange, including banking, construction and telecoms sectors, is outshining Western Europe’s floundering exchanges. “Attracting listings from further out in the region, especially some of the more exotic areas, would cement Istanbul's attractiveness for investors,” said Carré.

Turkey’s domestic equities market has been primarily owned by foreigners, but for years there weren’t enough investment products despite a “statistically significant” domestic investor base, said Serkan Gur, executive director at Crossbridge Capital.

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“The capital markets were largely dominated by commercial banks but not by institutional investors as is the case in developed markets,” Gur said. “This is all changing now with new incentives and financial measures taken recently by the government."

He said private pension funds will be a major player in the equity markets and that portfolio management companies are being set up to offer a larger client base a wider range of products.

"It’s certain that foreign investors will find better liquidity with lower risks in the Turkish money and capital markets,” Gur said.

Gur predicts Fitch will upgrade Turkey to investment grade this year, and Moody’s will follow by the end of next year. That creates potential for strong returns with equities, bonds (domestic and international), local currency, as well as liquid ETFs and equity linked structured products, he said. “One can benefit hugely by entering into cross currency asset swaps with domestic Turkish bonds underneath,” he said, noting that typically when a country becomes investment grade, markets rise for about three months to six months and then the currency becomes overvalued and current account deficits worsen.

That can be a lucrative period for investors, unless the central bank applies very solid fiscal policies, especially after the upgrade.

Maslak is a neighborhood and one of the main business districts of Istanbul, Turkey.
Salvator Barki | Gallo Images | Getty Images
Maslak is a neighborhood and one of the main business districts of Istanbul, Turkey.

When it comes to foreign direct investment, said Gur, energy, transport and infrastructure will always be profitable and safe plays in Turkey because more than 70 percent of energy resources are located in the south and east of Turkey, while the largest energy consumer, Europe, is located to the west of Turkey.

“FDI success requires government dedication and political stability, both of which are in place stronger than they have ever been in Turkey’s history,” he said.

There also opportunities for private equity to profit from a growing and developing country with many opportunities, Gur said.

Ercan Guner, manager of the HSBC GIF Turkey Equity Fund , recommends mutual funds because they are managed by portfolio managers with local expertise, which “enables funds to outperform the markets,” he said. “In addition, mutual funds also remove the burden of following political, economic, industrial and company- specific developments closely from the foreign investors.”

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Based on a top-down analysis, Guner recommends banking, electric utilities and real estate.

“Under the light of further privatization and with an expectation of a sovereign rating upgrade, (the) Turkish banking sector seems to be an attractive investment play,” said Guner. He forecasts strong growth for both project finance and consumer loans, while the expected upgrade to investment grade would create a lower cost of risk, easier access to cheaper sources of wholesale borrowing and increased demand for loans with increased interest rate stability.

One seasoned emerging markets investor urges caution, however.

"While there are dedicated Turkish equity funds (most of them are domiciled in Europe or in Turkey), exposure is best achieved through more diversified regional or EM funds in order to tamper volatility,” said Mark Mobius, executive chairman of the Templeton Emerging Markets Group .