How Turkey Could Impact Emerging Markets Investments

Jeremy Glaser: From Morningstar, I'm Jeremy Glaser. Markets have been roiled recently by developments in Turkey. I'm with Karin Anderson, she's an associate director on our manager research team, to look at what's happening there and how it's impacting the fund world. 

Karin, thanks for joining me.

Karin Anderson: Hi, Jeremy. Thank you very much for having me.

Glaser: Can we start just by talking a little bit about what's happening in Turkey? We all saw the headlines of the plummet in the currency, but what's behind some of these moves?

Anderson: Emerging-markets securities were already having a really tough year before a few things happened in July that caused Turkey's currency, the lira, to plummet and its debt. Those few things were, one, the central bank did not hike rates as the market expected in order to tame inflation. It's running at about 16%, so the market was really looking for that to happen. Another thing that happened was the ECB announced concerns about its banks' positions in Turkey, in the currency in different debt positions. Also the U.S. announced tariffs on steel and aluminum. Three very negative things happened and caused, one, the currency to plummet; it's down about a third, year to date. A lot of that actually happened in a very abrupt move starting in July. That definitely spooked the markets.

If you looked at Turkish equities, that's a really concentrated small group, mostly banks. Those are down about 10%. If you look at the TUR, which is the iShares Turkey fund, that is actually trading at levels that are on par with the very end of the global financial crisis--a very low level there. When you look at emerging-markets bonds, so that's the Turkish hard currency sovereigns and the Turkish local currency sovereigns, so those are denominated in lira, those are down about 10% to 14% on the year. Again, a lot of that pain came just very, very quickly.

Glaser: When you look at these big drops, it can certainly be scary. For most investors, how are they exposed, if you have some emerging markets exposure, how much of it is Turkey?

Anderson: These declines are very scary, but in reality investors probably don't have very much exposure to Turkey. EM equity investors, those that maybe have a dedicated EM fund--if you look at that key index, Turkey is less than 1%  of that. There you're not gonna have very much exposure to, say, some of these banks that have been hit. 

I the fixed-income space, a little bit more so. If you look at the hard currency and local currency denominated J.P. Morgan indexes, Turkey is kind of a midsize player there, about 3%. If you own a dedicated EM bond fund, you might have a little bit of exposure there to the sovereigns and the currency. That said, that's one of many holdings there. Across the board they have been hit, Turkey and Argentina, very hard this year, but overall in a well diversified fixed-income portfolio that should be a pretty small piece.

Glaser: Let's talk a little more about that contagion. When you talk to managers, what are they thinking about if these problems are going to spill out into the broader emerging markets?

Anderson: Some managers are seeing some opportunities here, some overshoots in countries that have sold off in tandem with Turkey, because they just don't see the same types of issues there. Others are definitely more concerned about contagion effects and perhaps avoiding the Turkish lira because of potential for further declines. Broadly, the managers that we speak with don't think there's going to be a magic solution in the near term with the president and the authorities there making the necessarily increases to interest rates that the market was really looking for in July, or on the other hand, going to the IMF. It's pretty clear that they aren't interested in doing either of those in the near term. 

The market did see a little bit of a pause in the sell-off this week. They took a couple smaller measures in terms of trying to stop some of the short selling on the currency side and then also loosening some regulations for the banks. Maybe a little bit of a near term band-aid for the situation, but I think EM investors are genuinely hoping for the kind of classic responses to the monetary policy. When you have inflation at 16%, the market wants to see interest-rate hikes to offset that.

Glaser: Karin, thanks for sharing your thoughts on the Turkey situation today.

Anderson: No problem. Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.