Buy Turkey

07 Dec 2015

I was discussing the relative value of the forthcoming Turkish covered bonds recently with a friend (a friend mandated on one of them so he should know what he’s talking about). I was slightly shocked by the approach to relative value. Needless to say, given the A3 Moody’s ratings on all three of the prospective programmes the spread is likely to be very generous compared with A3 rated deals from more established countries. 

There are many possible explanations of this, most of them don’t stand up to very much analysis.

Firstly, it’s a debut issuer from a debut country. Fair enough, it is traditional to leave a few basis points on the table by way of marketing for the next deal, thanks for doing all of that credit work, uncertainty margin given the greater subjectivity of the price discovery process. Counting against all of these though is the very significant benefit of diversification into an economy that is weakly correlated to all of the other economies that your portfolio is exposed to.

A similar value proposition then to the Singaporean debutant who hardly had to pay up at all on relative value terms.

Then there is the possibility that the market doesn’t trust the A3 rating. I’ll disagree with the market on that one. Moody’s might be wrong (a slightly meaningless concept in the business of assigning ex ante probabilities to events. If an event occurs it doesn’t mean that the person who said it has a 1% chance of occurring was wrong) but they are at least consistently wrong – an A3 covered bond in country A is as risky as one in country B. 

The sovereign spread is another possible excuse for a higher covered bond coupon. But if the crisis taught us anything it is the breakdown in the relationship between sovereign and covered bond credit. No Italian issuer would tolerate the inflated level of BTPs as an excuse for a wide spread on their covered bonds.

Which leaves us with some technical factors.

Turkish covered bonds aren’t eligible for the ECB’s purchase programme. Neither are, for example, British covered bonds, but their spread levels are tighter as a result of it, as portfolio theory would suggest. The purchase programme is pushing investors to seek out precisely this type of risk/return. 

So we are down to the biggest technical factor of all – I can’t buy bonds that don’t meet the EU definitions of covered bonds. UCITS and all of the regulations which flow from it are predicated on one key definition – that the issuer is in the EEA. Again our Singaporean, or for that matter Australian or Canadian, friends don’t suffer too much from that.

More importantly the EC consultation discusses a redefinition of this key criteria. Just a personal opinion but a relaxation of the ‘EEA-only’ rule has to be on the cards sooner rather than later.

Not many of the justifications for a higher spread seem to be particularly robust, most of them seem likely to fall away over the lifetime of the debut bonds

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