2023-03-14 12:14:55 ET
Summary
- The iShares MSCI Turkey ETF has outperformed the rest of the emerging market universe over the last year.
- While the earthquakes this year will weigh on growth, the diversified nature of the portfolio earnings means any structural impact is likely limited.
- The main risk remains the currency, which could see more downside amid continued monetary accommodation and foreign outflows.
The iShares MSCI Turkey ETF (TUR) has held up surprisingly well YTD through the catastrophic earthquakes last month. That doesn't mean Turkish equities are in the clear, though, as the impact of the earthquake will have near-term economic implications for the country. On the one hand, companies with operations in the affected regions will suffer from the disruptions. On the other hand, there is ample fiscal room for post-earthquake reconstruction, given the low debt to GDP, which creates meaningful growth tailwinds into H2 and beyond. The composition of the TUR portfolio, which skews toward diversified conglomerates like Koc Holding ( KHOLY ) and Sabanci Holding ( HOSZY ), as well as companies with exposure to ex-Turkey revenue streams like Turkish Airlines ( TKHVY ), means the overall earnings impact should be limited. That said, the economy continues to suffer from structural issues, including elevated inflation and persistently wide current account/fiscal deficits. Regulatory support has helped to prop up the lira thus far, but with monetary and fiscal policy likely to remain accommodative heading into the elections, the FX downside risk warrants a neutral rating on TUR.
Fund Overview - A Low-Cost, Concentrated Vehicle for Turkish Large-Cap Exposure
The US-listed iShares MSCI Turkey ETF seeks to track, before fees and expenses, the performance of the MSCI Turkey IMI 25/50 Index, comprising the large, mid, and small-cap segments of the Turkish equity market or ~99% of the free float-adjusted market cap. The ETF held $332m of net assets at the time of writing and charged a 0.6% expense ratio, making it a cost-effective option for US investors looking to express a single-country view on Turkish equities. A summary of key facts about the ETF is listed in the graphic below:
At the top of the fund's sector allocation is Industrials, which has a 28.4% weighting. The TUR portfolio also retains heavy exposure to Materials and Financials at 19.7% and 16.3%, respectively. Other major sector allocations include Consumer Staples at 9.8% and Consumer Discretionary at 9.2%. On a cumulative basis, the top five sectors accounted for ~83% of the total portfolio. It is worth noting, however, that iShares has opted to classify conglomerates with holdings across different sectors under the 'Industrials' category, so the portfolio is more diversified than it looks at first glance.
On a single-stock basis, the portfolio is fairly evenly spread out across 62 holdings. The largest portfolio holding is Turkish refiner Türkiye Petrol Rafinerileri ( TUPRF ) at 6.8%, followed by national carrier Turkish Airlines at 5.7%. TUR also holds many of the country's largest conglomerates, with KOC Holding and Sabanc? Holding at 5.4% and 3.8%, respectively. Other key portfolio components include a 5.4% allocation to Sisecam Turkey ( TKKYY ) and a 5.2% allocation to discount store BIM ( BMBRF ). With the top five holdings accounting for ~28% of the overall portfolio, TUR is one of the more well-diversified emerging market ETFs on the market.
On a YTD basis, the ETF has declined by 4.0% and has only compounded at a 0.4% rate in market price terms (+0.3% in NAV terms) since its inception in 2008. While much of the appreciation has occurred in recent years, the rate of growth has been exceptionally volatile, with the ETF appreciating 106.4% in 2022 after suffering a -27.5% decline in 2021. Similarly, TUR's outperformance in 2019 at +13.9% followed a -41.4% decline in the prior year. With the exception of the COVID-impacted 2020, the distribution has been steady, reflecting the fund's outsized allocation to cash-rich conglomerates. Given the ~2.2% trailing twelve-month yield and the volatility of the capital returns component, however, there are probably better alternatives for income-focused investors.
Fundamental Economic Issues Remain Unaddressed
Turkish economic data ended 2022 strongly, with a +3.5% YoY GDP report for Q4 on the back of a private and public consumption boost. The headline numbers were massively helped, though, by a pull-forward in consumption due to the inflationary dynamics (>50% YoY per recent data ). The sustainability of last year's growth is also in question, given the near-term fallout from the earthquakes, which will inevitably have an adverse impact on overall economic activity. Increased political noise ahead of the June elections adds to the uncertainty. Perhaps most importantly, though, the structural issues remain unaddressed - the exceptionally high inflation (and reduced purchasing power) is the key domestic headwind, along with the persistent fiscal and current account deficits. Given the limited political will to address the deficit through fiscal means, monetizing is the most likely go-to option at this point. The latter option comes with a steep price for the lira, though, and could worsen the inflation dynamics post-earthquakes as well.
Thus far, the earthquakes and the upcoming elections have led to the Turkish central bank maintaining an accommodative stance - at the most recent February policy meeting, the CBT announced a 50bps rate cut and included commentary suggesting more of the same through H1. While this is supportive of growth, it comes at the cost of stoking more inflation and, most worryingly, further depreciating the currency. Support from recent FX-related regulatory measures such as backstopping lira-denominated deposits against mark-to-market losses and the mandatory repatriation of ~40% of export proceeds simply aren't sustainable solutions. Pending concrete measures to address the widening current account deficit and to stem the inflationary impulse over the mid to long-term, it's hard to look past the FX downside amid continued foreign outflows.
Single Stock Implications - Not All Bad
What is certain about the coming corporate earnings reports is more volatility as Turkish companies navigate the earthquake impact for the year. For most of the companies within the TUR portfolio, however, the downside risk is likely to be limited. The fund's largest sector allocation, energy, for instance, has a rather inelastic demand curve and should see no major adverse effects in the short term. As reconstruction efforts kick-off, on the other hand, expect the increased demand for energy and refinery products to benefit key holdings such as Tüpra? ('Türkiye Petrol Rafinerileri'). There will be a marginal impact on major conglomerates like Sabanci, which has non-life insurance exposure via Aksigorta ( AKSGY ), as well as electricity distribution exposure via EnerjiSA, which operates in the earthquake-impacted cities. On the other hand, both of TUR's major conglomerate holdings, Sabanci and Koc, are also exposed to post-earthquake rebuilding activity in the region, so the mid to long-term earnings impact could even be a net positive. Elsewhere, companies with a lower % of Turkish revenue generation, such as Turkish Airlines (the second-largest TUR holding), should also face limited earnings impact.
The Post-Earthquake Outlook
Following the 2022 rebound, the outlook for Turkish equities looks more uncertain this year, given the fallout from the recent earthquake. The market seems to be expressing the view that any impact will be limited to a handful of affected regions, with post-earthquake reconstruction activity offsetting much of the H1 headwinds. Given TUR's focus on conglomerates and geographically diversified large-caps, as well as its limited allocation toward affected sub-sectors like insurance, I largely agree with this view and expect any earnings weakness to reverse in H2. Yet, it's hard to ignore the underlying Turkish economic trend, particularly with regard to the double-digit inflation rate and widening deficits. With monetary policy also staying excessively loose ahead of an election cycle and much of the FX-related regulatory support already played out, TUR's lira exposure remains an overarching concern.
For further details see:
TUR: Assessing The Post-Earthquake Outlook