The Daily Update - Turkey Republic vs Microsoft

During our selection process one of the most important factors of selecting a bond, aside from the country's Net Foreign Asset (NFA) position, is the risk-adjusted return; we use the expected return and yield, and notch protection as two of the main identifiers. Although we do not typically invest in sub-investment grade bonds across our portfolios, we do still monitor them; especially as we can hold junk bonds in one of our funds.

Turkey, for all its faults has never been a favoured nation for us due to its shaky economic fundamentals; the country was downgraded to junk in 2016 by Moody’s and then in 2017 by Fitch. Although it would have been included in our investable universe up until 2007, when it still held a three star NFA ranking, we have never bought Turkey, we have only ever held short positions previously (in our long/short strategy).

Looking at today’s numbers, it is still some surprise to us that Turkey’s bonds are still held by many. We suspect yield hungry investors will love the nation’s bonds; the Republic's 4.875% issue, maturing in 2043 for example has an ‘attractive’ yield above 7% currently. However, looking closer at the numbers, we calculate that the bond is trading ‘expensively’, with an expected return of close to negative 3%, thus the return and yield is calculated at ~4%. In terms of notch protection, the market is actually pricing the Ba3 rated bond as a Ba2 rated security.

If we compare this with a bond with a similar duration of ~12.3 years, i.e. Microsoft Corporation 4.1% 2037 we can see why this would be a preferred holding. For a start, this bond has a AAA rating and the US is rated 3 stars. Our model calculates that the Microsoft bond offers an expected return of 7.4%, and although its yield is not as attractive as Turkey’s, the yield and return is estimated at ~11%. The Microsoft issue is also over 4 notches ‘cheap’, thus allowing sufficient downside protection; we think it will be some time before the US’ rating is downgraded.

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