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Cerulli Global Edge, August 2009

Turkey’s asset management industry is awaiting a seismic shift. A proposed new law, likely to take effect next year, has the potential to transform this industry, increasing competition and bringing the likely advent of open architecture. It will also make it a more attractive country for foreign institutions.

Turkey today has a sophisticated mutual fund industry, dating back over 20 years: its Capital Markets Law was passed in 1981, with the first communiqué on mutual funds appearing in 1986, and the first fund launched later that year. In aggregate, the fund industry has about US$25.5 billion under management in 2009, down from a peak of US$28.1 billion in 2007.

While Turkey’s asset management industry has grown considerably – six times over between 2002 and 2005 – it is still not a large proportion of addressable assets. HSBC says the allocation of savings in late 2008 was 79% deposits, 7% mutual funds, 6% treasuries and 5% equities, with a few other investments making up the remainder; it says the Turkish fund industry represents only 3.5% of 2007 GNP. A leading local investment group, AK Portfoy, puts mutual funds at just 3% of addressable assets, and points out that Turkey’s 70 million people have between them 90 million deposit accounts, 25 million credit card clients but just 2.7 million mutual fund investors – of whom well over 2 million are only in money market funds.

Turkey’s mutual fund industry is in many ways quite different from others. Ever since 1996, mutual funds have been split into two classifications, Type A and Type B. Type A funds must invest at least 25% of their funds in equities issued by Turkish companies. Type B funds have no such restrictions. In practice, Type A funds are typically equity products, and Type B, fixed income or money market.

The distinction used to exist for tax reasons but has little relevance today; industry bodies are seeking to abolish this archaic separation in favour of more globally accepted fund classifications. But the more relevant point is this: it’s the latter camp, Type B, that is the vast majority of the industry. According to AK Portfoy, B type funds – fixed income and money market – have US$18.5 billion under management, and A type $526 million (although the number of funds is much closer – 120 Type A versus 179 Type B, according to data from the Turkish Institutional Investor Managers Association). Equities accounted for just 2% of the industry as of November 30 2008; fixed income, 12%; and money market products some 86% of the industry, despite the fact that there are less than half as many funds (51) as there are equity funds. One could argue whether these money market funds are mutual funds in the traditional sense at all – often they are used as cash accounts, with bill payments coming in and out of them.

Why don’t Turkish investors like equities? Because there are better alternatives elsewhere. Deposit accounts offer extraordinarily high rates of return with limited risk: well over 20% was commonplace in products of one to three month duration at the end of last year. Since then the Turkish Central Bank’s Monetary Policy Committee has cut the country’s policy rate by 50 basis points from 9.25% to 8.75%, bringing deposit rates down accordingly, but they are still very high.

In that situation, there is little incentive to go into mutual funds, and almost none to go into equity funds. What’s the sense in equity risk when one can attain around 20% with minimal risk in a short term product? (Strangely, the shorter end of the curve has tended to offer the best returns lately, due in part to Turkey’s history of inflationary pressure.)

The allure of mutual funds is hardly assisted by extraordinarily high fees. Typically the up-front and management fee are bundled together – which means, effectively, customers are paying the up-front fee not just once but annually. Fees of 3-5.6% a year are common on equity funds, of which a large chunk goes towards distribution. Even in money market funds, fees of 4 to 5% are not uncommon. These are some with lower fees, but they then tend to add an exit fee.

Another oddity of the fund management system today is that fund managers can’t, independently, launch funds themselves – they have to be launched by the distributors, who are banks, pension companies and securities companies (in 90% of cases, it’s the banks). Consequently, banks sell their own products, and the biggest players in the industry by far are asset management companies connected to the banks: each of Yapi Kredi, Is, AK, Garanti and Ziraat, the top five members of the 22-strong asset management industry who between them control 79.6% of total assets, are 100% subsidiaries of large retail banks.

The new law proposed by the Capital Markets Board of Turkey proposes many changes, but this is probably the biggest: after the law is approved, asset managers will be able to establish and distribute their own funds. There are other elements to it too – greater compliance with EU standards and UCITS directives, gathering capital market instruments under a single notion of financial assets, and constructing open-ended investment companies – but it’s this rule on the founders of funds that will have the broadest impact. It is expected to increase competition, improve the quality and diversity of services, reduce fees, increase specialization through the widespread use of outsourcing, and bring about open architecture in marketing channels. Fund sizes are expected to increase, on average, while it is also expected that foreign asset management companies will have more incentive to invest in Turkey and foreign investors will be more inclined to seek exposure to Turkish funds.

For the first time, then, we may see an avenue for international fund managers to sell product in Turkey, since it will be easier to negotiate distribution arrangements in a more open architecture environment. Persuading investors there is any sense in taking global equity risk will be a bigger challenge, but there is certainly an opportunity.

In fact, foreign entrants do already have a strong presence in Turkey, although frequently it is indirect. HSBC and ING operate directly as asset managers in Turkey under their own names, but in fact 15 of the 22 investment companies in Turkey have foreign shareholders somewhere in their ownership structure. Most frequently this is because they have a stake in the retail bank that owns the fund manager: this is the case in Yapi Kredi (part owned by Italy’s Unicredito), Garanti (part owned by GE Money), TEB (BNP Paribas), Oyak (ING), Deniz (Dexia), AK (Citi, indirectly, and without influence on the asset management business), Bender (Deutsche) and FinansBank (NB Greece). In theory one could argue that foreigners are involved in about 55% of assets under management in Turkey, but in terms of direct hands-on ownership it’s really only HSBC and Fortis who are highly active in their own name in asset management.

While the new law will make significant changes in Turkey, there have in fact been major developments in recent years, chiefly the development of the pension industry. This dates from the introduction of a private pension scheme in 2003, under an arrangement where pension products are launched by retirement companies but managed by asset management companies. From US$31 million in 2003, this industry had grown dramatically to US$4.89 billion in 2009 – avoiding a decline in 2008, unlike most areas of asset management worldwide – and is the area many asset managers are most excited about. It has a more obvious appeal to investors since no income tax is levied on gains (although it is applied at varying levels when an individual leaves the system), and follows a defined contribution, voluntary participation model. Given the length of time involved in a pension, Turkish investors seem more willing to consider committing capital to risk-bearing assets.

Pension fund allocation looks a little different from mutual funds, with equities up to 8% – more than mutual funds but still tiny by world standards. Fixed income is the dominant asset class in this area, accounting for 69% of the market. YapiKredi said that in late 2008, there were 114 pension funds available, with 4.97 million customers.

Another interesting area of development has been structured funds, which were only permitted to be launched in 2007. Four funds had been launched by December of that year, and by November 2008, the number was up to 21. In the main these are capital protected or capital guaranteed products. These funds have struck a chord because they shift the risk/reward equation in a way that makes them more interesting for Turkish investors. Since they have previously been able to access high returns in deposits with low risk, there has been little need to consider other products that do carry risk. Once a capital guarantee is introduced, the picture looks more attractive.

At the time of writing, development in this area was on hold while asset management companies wait for new legislation governing an umbrella structure for the establishment of structured funds. This new legislation has just been approved by the Capital Markets Board and should take effect shortly; in its wake, all major fund managers are expected to establish new umbrella funds, and within them, new structured products.

Turkey also supports a nascent discretionary portfolio industry, and modest corporate mandates. Sponsors are now permitted to launch hedge funds, though in practice few have bothered to do so yet. By the end of 2008 three banks and one brokerage had received approval to establish these funds, known locally as free investment funds or FIFs, but none had yet done so, though Yapi Kredi, Is and Garanti were believed to have them under development.

Chris Wright
Chris Wright
Chris is a journalist specialising in business and financial journalism across Asia, Australia and the Middle East. He is Asia editor for Euromoney magazine and has written for publications including the Financial Times, Institutional Investor, Forbes, Asiamoney, the Australian Financial Review, Discovery Channel Magazine, Qantas: The Australian Way and BRW. He is the author of No More Worlds to Conquer, published by HarperCollins.

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