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In yield-starved world, emerging market debt attracts assets

When Moody’s downgraded Turkey’s credit rating to below investment grade on Friday, September 23, few were surprised when the country’s debt and equity markets sold off the following Monday. More surprising, however, were the results of an auction of new government 10-year notes: the debt offering received the most bids in nearly two years.

Turkey’s most successful local bond sale since 2014 indicates what many are calling the bottom of a recent selloff, which began after the attempted military coup in July sent protestors into the streets and bond yields up nearly a full percentage point.

Today, with Turkish debt yields near 10 percent, investors are looking at the emerging market nation with new eyes in light of near zero to negative rates in parts of the developed world. This year, more than $4.37 billion has flowed into Turkish sovereign bonds, according to central bank data.

The Turkish trend isn’t isolated. Fund data provider Morningstar reports that investors poured $4.2 billion into all emerging market debt funds in July and August. What’s the reason? In a word: yield.

“Everyone is looking for yield,” says Jamal Elbarmil, who is the co-portfolio manager of the Azzad Wise Capital Fund, an alternative international income fund with a sizable exposure to Turkish fixed income. “This is why is an appealing investment for those able to tolerate more marginal risk. We’re starting to see our Turkish banks offering more attractive rates to draw investors to participate in their profit- and loss-sharing accounts. And of course, any new sovereign debt issues will offer more attractive yields following the downgrade.”

So far this year, emerging-market debt funds are up an average 12.37%, following a dismal performance in 2015 when they returned an average -6%. Most of those funds’ holdings are denominated in dollars rather than local currency in order to minimize currency risk. That’s important considering the other risks of investing in emerging markets that investors cannot hedge against–for instance, political upheaval and unchecked inflation.

How long will the trend toward emerging markets continue? That depends partly on economic growth and central bank monetary policy. Many say that until the world economy can sustain a higher interest rate environment, opportunities for yield in developed markets will be few and far between.

For Turkey at least, the clouds appear to have cleared. “Markets now have more certainty,” says Elbarmil. “And assets that had previously been ignored by some institutional investors are now looking attractive.”

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