Turkey: the asset management industry
Asset management constitutes a relatively small and underperforming area of Turkey's financial services industry. To date, structural factors have constrained the growth of the asset management industry - foremost Turkey's volatility and the extremely high interest rates on short-term deposits established to compensate. Asset management has been likewise ill-served by restrictive regulation. At the time of writing, asset management companies were barred from designing funds' strategies, from marketing them and it was necessary for funds to be sponsored by banks.
This has resulted in a market which, in the words of Eczacıbası Securities' Salih Reisoglu, "lacks capital, savings and appetite". The total percentage of GDP represented by funds is currently 4.3%, very low when compared with eastern Europe's 7%, a peer group average of 15.6% and the global average of 24.5%. Crucially, about 96% of the funds in Turkey are formed of fixed income securities - government bonds and bills and overnight deposits. The figures for money markets to GDP are better: 3.5%, compared to eastern Europe's 2.4 %, a peer group average of 3.2% and a global average of 4%. But as Cem Yalçınkaya of AK Asset Management notes, "money market funds are not really funds", their chief attraction for Turkish investors stemming from the potential from tax avoidance rather than the prospect of returns. Equity and fixed income funds together make up just 0.8% of GDP, startlingly low when put alongside the US at 80%, eastern Europe at 4.5%, a peer group average of 12.4% and a global average of 20.6%.
That said, the industry is set to undergo potentially quite a dramatic transformation. This is in part thanks to the general trends supporting the financial sector as a whole - namely, steadily decreasing interest rates and reduced stock market volatility - but also, and more specifically, thanks to sweeping reforms to the rules governing the sector and Turkey's burgeoning private pensions system. Forecasts for long-term growth in equity funds suggest an increase over the next decade to about 20% of GDP, growing at an average of around 45% per year. Fixed income funds are expected to increase at about 35% per year and money markets at about 10-15%. In a nutshell, equity funds are set to grow and make up a growing portion of funds.
This transformation will not, however, be achieved overnight. Turkey's volatility has decreased markedly, but where 2007 saw a 200% rise in the net asset value of investment funds, 2006 saw a 37% fall. Similarly, although interest rates are now down from the 40% of a decade ago, they still remain too high to make funds attractive and were hiked as recently as June 2007. When real interest rates drop from their current levels of 10% to 12% to 6% to 8%, funds will improve, but the shift of capital away from short-term deposits will be a long one, given that the latter currently make up between 60% and 70% of GDP. Any shift will be further slowed by the fact that about 37% of the overall deposit base - almost $96bn (€64.8bn) - is in FX terms.
Structural shifts aside, the most signal trend is the fact that industry and regulator alike are making conscious steps to revamp the industry. The most significant of these is the ‘twinning project' of the Capital Markets Board (CMB) that will twin the fund law of the CMB with the EU's UCITS III. Companies will be entitled to both found and manage fund assets and, whereas before there was ambiguity about the depository institution, this is clearly defined in the new legislation. This more proactive and supportive approach to asset management by the regulator marks a notable shift from its previous approach. In essence asset management developed rather accidentally, the result of the CMB mandating it into existence by removing first banks and then brokerage houses right to offer such services.
Among the most significant of these decisions was the step taken in 2000 to rule that management of the nascent private pension funds could only be performed by specially designated asset management companies. Those financial institutions that saw the potential of pension funds and established separate asset management companies and saw these companies, almost organically, attract the vast majority of institutional investor portfolios of institutional investors. Currently in the region of 80% of funds are managed by asset management companies, while in the region of 20% remain with the brokerage houses, pretty much exclusively the result of the houses carrying out individual portfolio management. In general, the brokerage houses will have a nominal client relationship with the funds and are simply trusted to run the portfolio alongside their other activities
Pensions - something for the future
The private pensions market has grown phenomenally since its introduction. Despite the establishing law dating back to 2000, private pensions only appeared on the market in 2003-4 with an initial asset size of roughly YTL300m (€175.1m). By 2007, the figure had reached YTL 4.5bn - by far the biggest growth rate of any financial instrument in Turkey. A key factor in this growth has been the active support given to it by a government desperate to reduce a gaping budget deficit almost exclusively the result of a bankrupt social security system. These steps include passing a vesting law making the system more attractive to corporations, and introducing tax incentives to make the system more attractive to low-income individuals.
Although, the government is somewhat limited in creating further incentives due to the requirement to produce a high enough primary surplus to service government debt, future growth prospects for pensions are healthy. Not unreasonably, Turkish companies point to the example of Latin America where private pensions reached 8% of GDP after 10 years. In the case of Turkey, wide estimates of a GDP between $800-900bn by 2017 suggest to Oyak Portföy that accumulated pensions should reach $80-90bn by the same year.
Further afield, Didem Gordon of Yapı Kredi Asset Management is confident that the asset management industry's successful stewardship of domestic private pensions, and experience in advising international pension funds on their Turkish investments, has created the mouth-watering prospect of the industry becoming involved in managing the state pension system as ground-breaking social security reforms gather pace throughout 2008. As well as managing the domestic private pensions market, asset management companies like Yapi Kredi have also gained experience managing the Turkish investments of foreign pension funds. A further side benefit, though more debatable - is put forward by Is Asset Management's Gürman Tevfik who speculates that as more and more people become involved in private pensions, they will become more used to the idea of long-term investing, thus benefiting the asset management industry as a whole.
Adaptations and Innovations
Although there may indeed be a positive psychological impact of a successful and widely used private pensions system, others prefer to put their faith - and business - into the introduction of a new suite of instruments. These instruments - some internationally-focused, others more focused on the need to offer an element of security - in some ways mirror the intended future development of the industry as a whole - more stable and more linked to the global economy.
Taking the instruments aimed to address the risk-averse nature of the Turkish investor first, the CMB has now sanctioned capital-protected and capital-guaranteed funds. Capital-protected funds were among the earliest, the first being issued by Ak Asset Management and Fortis at the end of 2007. Cem Yalçınkaya is optimistic about the funds, confidently predicting that they could easily rise from the present 0% of GDP to 2%. Yapi Kredi Asset Management has similar hopes for its capital-guaranteed fund, launched at roughly the same time. Others are less sure, among them Tankut Taner Çelik of Oyak Portföy. According to his view, the fact that banks can offer similar indexed deposit accounts, which are much more flexible and easier to market than funds, means that if they were to choose to launch such indexed deposit products, the market for ‘secure' funds would be decimated.
A further development has been the CMB's sanctioning of hedge funds and funds of funds. Yapi Kredi Portföy has just launched one of the first of the latter, the World Fund of Funds, containing a mix of Turkish and international funds. In the eyes of Salih Reisglu this could represent a revolution for the industry for the potential they have to kick-start the development of fund manager selection and assessment. Further to this, at present domestic investors are mostly directed by the existing tax law to invest locally. The only charge on domestic investments is a withholding tax on the intermediary institution - between 10% and 15% depending on the instrument. Foreign investments, however, require the declaration of all returns and involve a tax set according to one's personal earnings, for most investors around 35%. In practical terms, the message is ‘don't invest overseas'.
Funds of funds can be made up of overseas as well as domestic products but taxed at the local rate, thus creating a pathway for investors to global markets, an event that could go a significant way to bolstering domestic interest in equities more generally. Developing hedge funds will clearly take time, given the low base, but there are five or six firms making the initial steps to establish such funds, naturally with much less leverage and smaller risk than in other markets, but the basic idea of getting absolute returns for investors, rather than just benchmark-orientated management is there.
Another area for the future worth briefly noting for its uniqueness is Islamic asset management. Currently there is only one Islamic brokerage firm to complement the Turkey's four Islamic or 'participation' banks. The company - called BMD - currently manages several funds distributed through the banks. Uniquely for Turkey - where mutual funds did not distribute dividends for purely technical reasons - the precepts of Islamic finance required that BMD develop a system for manual distribution of dividends and was eventually successful in lobbying Tekas Bank (the official settlement bank of the ISE) and the MKK to adopt a process for distributing these electronically.
Unsurprisingly, Turkey's recent record of impressive growth and stability have created no small appetite among retail investors abroad to play a part in the country's longer term prospects. Foreigners make up a large part of those investing in equity funds, having invested $3.5bn compared with $500m from Turkish investors. Ak Asset Management is only the most recent company looking to cater to this demand by launching Turkish equity funds exclusively targeting international retail investors. In so doing, it is treading a path laid down by firms such as Oyak Portföy, Yapi Kredi Asset Management and Is Asset Management. It will be hoping to follow the example of the latter as the efforts of both Oyak Portföy and Yapi Kredi Asset Management floundered in the aftermath of the 2001 crisis.
The once-burnt-twice-shy Taner Çelik of Oyak Portföy, believes that foreign investors seeking Turkish exposure can just as easily access it through the offshore market, structured products, or funds based on those products. Nevertheless, he also points out that although unique, the success of Is Asset Management's Tukis fund denotes that similar products can work if they are carefully and closely managed. As Gürman Tevfik of Is Asset Management argues: "In essence, running a fund and running a restaurant is very much the same business: you need to educate the customer to a certain extent about what you are selling, but at the same time it is your job to offer a selection of food that will not sit ill in the customer's belly or have a taste that is simply too different from their normal fare that they will notice the difference more than the taste." As Turkish risk becomes an increasingly common item on the international economic menu, that job may well get easier and the balance sheet healthier.
With growth in the pensions market, a raft of new instruments and important changes to their regulation, Turkish asset management firms are looking to the future with relish. Particularly invigorating is evidence of a slow take-off in the number of Turkish institutional investors, a trend being actively encouraged by the government, regulators and industry alike. While all this change presents a great opportunity, the onus to adapt quickly to take advantage will require consistent and heightened efforts if the George Soros' adage that "long-term investment means failed speculation" is to be disproved.