The strength of the Turkish financial system has laid the groundwork for more sophisticated investment tools, creating a longer-term investment horizon.

Dr. Gürman Tevfik
İş Asset Management
Didem Gordon
Managing Partner
Libera Portföy

What is your assessment of the Turkish fund industry, and how will it mature?

DR. GÜRMAN TEVFİK In Turkey there are two different types of mutual funds: one is set up for pension purposes, the other is structured for investment purposes. One can be promoted by pension companies, the other only by banks and brokerage firms. This means the regulatory environment is different than in the US and Europe. Pension funds are a new subject in Turkey, and the third pillar pension system only got started in late 2003. In Turkey, the first pillar system was common before. It's like the social security system in the US, which is also a first pillar system. In Turkey, the total volume of the third pillar pension system's fund assets reached TL13 billion. The first pillar system isn't deemed adequate for pension needs, that's why the third pillar system was brought in. In Turkey there is also second pillar, a few companies have it, including our mother company İş Bank. Our second pillar pension fund owns 46% of the bank's shares, and so our employees are also stakeholders in the company via this pension system. The third pillar is now getting a lot of attention. There are 2.4 million people in the third pillar and it's growing fast.

DİDEM GORDON Time will tell. Currently, around 80% of Turkish mutual funds are in money market funds. Over 75% of household wealth is in deposits in the financial system. This implies that there isn't a very long-term investment horizon. However, with the start of the private pension funds in 2003, there is hope. Now, the private pensions system, even though it is voluntary, has reached about TL12.4 billion, and it is growing every year in terms of net asset flows and also in terms of performance. I think this started to bring about a longer investment horizon; a critical turning point, I think. I expect a similar trend, longer-term investment, and more sophisticated product distribution in the mutual funds sector. I think if economic stability is preserved, more than half of our mutual funds should be in non-money market funds in five years from now. I am not saying that the money market funds are not going to be one of the big instruments in the market. However, I think other products, such as equity products, balanced funds, asset allocation funds, hedge funds, and other products will grow at a higher rate than money market products in the coming years. This will change the Turkish capital markets scene a bit. Currently, over 60% of the free float in the stock exchange is owned by foreign institutions. The remaining percentage is mostly Turkish individuals. Our sector, the fund industry, has a very small share. However, when we analyze developed markets and some of our developing neighbors in Europe, we see that local institutional investors started to get a higher share of equity investments in their local markets. This is bound to happen in Turkey, too. When it does, it will reduce the vulnerability of our capital markets and economy to foreign capital inflows.

Do you anticipate that Turkey's credit rating will be investment grade anytime soon?

GT If we look at the combined current account and budget deficits for the US it comes to 12.4% of GDP. In Greece it is 11.9%, in the UK 10.7%, Spain 10.5%, and Turkey 9.8%. But when you look at S&P ratings the US is AAA-, Greece is BB-, and Turkey BB. Spain's rating is AA. Spain's 10-year bond yield is 5.28%, and in Turkey it is 5.11%. And yet Spain gets an AA rating, while Turkey gets a BB rating. It is hard to understand why ratings agencies don't reflect these figures. According to the market, Turkey's bonds should be investment grade. It should be at least single A. I suppose the main issue here is politics.

What is your view of the regulatory framework for asset management in Turkey, and do you anticipate changes in the near future?

DG Yes I do, actually. As the Vice-Chairman of the Turkish Institutional Investment Managers Association, and head of the regulatory framework committee, I am actively involved in efforts to develop the fund business in Turkey. As representatives of the industry, we work on various proposals in respect to current regulation and fiscal policies governing institutional investors in Turkey. Our target is to bring our regulatory framework in parallel with those of developed markets, such as UCIT practices. We expect regulatory changes sometime in the second half of 2011. The Turkish Capital Markets Board is quite proactive and supports the industry with a vision to grow the capital markets. I believe we have come a long way, and we are close to reaching best practices in terms of industry structure and regulatory framework as well as the taxation of collective investment instruments. I am hoping that this will start taking place in 2011.

Is the corporate bond market in Turkey beginning to show signs of a resurgence?

GT The corporate bond legislation is very old. In the past no corporation wanted to issue corporate bonds. Also, corporate bonds had a disadvantage vis-à-vis government bonds due to taxation. There was an income tax of between 15% and 35% for any individual who wanted to invest in corporate bonds. Meanwhile, government bondholders were exempt from tax. No companies were able to handle the high interest rates and the taxation. Now, in a low-inflation environment and with low interest rates and also with equal taxation for both government and corporate bonds the situation is fair for corporate bonds.

Do you feel that Turkey is still vulnerable to the risks of so-called “hot money"?

DG I think most emerging economies are subject to this risk, especially those with above average growth rates such as Turkey. The FDI into Turkey has been quite strong in recent years, which is very positive. Turkey has managed to be a less vulnerable country over the past eight years in terms of economic development and infrastructural reforms. The portfolio investments into Turkey, naturally, are affected by global market conditions as well as country specific performance. Turkey, running a current account deficit and influenced by high petroleum prices, can be influenced negatively by the outflow of portfolio investments regardless of the reasons for the outflow.

This is, again, why we should grow the institutional investor base to make our capital markets less fragile. But if you look at the investment risk of Turkey compared to some developing markets, and even some European markets, I think we are in a significantly better position to attract foreign portfolio investments, even though they are likely to slow down over the short term. A continuing focus on economic stability, creating employment, and new reforms in social security and the pension system should help Turkey positively differentiate itself from other emerging markets and become less vulnerable.