If the investment income portion of your portfolio appears to be suffering from anorexia, we recommend spicing it up with the higher yields currently obtainable in very short term Volkswagen (OTCPK:VLKAF) bonds denominated in Turkish lira. These A3/A- rated, 8.5% coupon bonds mature in December 2013 and currently trade slightly below par, putting the yield to maturity at about 9.25%. After identifying these bonds for our clients, we noticed that Bank Audi released a comprehensive report on the performance of the Turkish economy and future outlook of this country which looks very promising. The Lebanese paper “The Daily Star” stated in the introduction of the report last Thursday, that “Amid the worsening sovereign debt problems in the eurozone, key policymakers showed a great deal of self confidence about Turkey’s conduct.” After reviewing the following report provided to our clients, perhaps you will agree with our recommendation to use the recent weakness of the Turkish lira relative to the U.S. dollar to acquire a high yield of lira and increase one’s exposure to the Turkish economy.
Corporate Bond linked to the Turkish Lira
Germany based Volkswagen AG has bonds, denominated in the Turkish lira, that currently has a yield of about 9.25% for 25 months. The high yield of this Turkey bond, with its A- rating, compares very favorably in relationship to other high yield instruments in our Foreign and World Fixed Income holdings. Aside from the U.S. dollar’s polarized response to the “on again, off again” fears over the euro’s future, the dollar’s longer term weakening trend against many world currencies remains a major concern for investors seeking protection against further erosion its buying power. This bond provides a significant diversification away from the U.S. dollar and towards an economy that has weathered the recent financial turmoil relatively well with no government bailouts.
U.S. Debt Woes
While the eyes of the financial world remain fixed on what is happening in Greece and Italy, it appears that the U.S. debt’s crossing the $15 trillion mark this week is barley worth mentioning. Yet, with only a week until the deadline to reach agreement on cutting $1.2 trillion to $1.5 trillion from the federal deficit over the next 10 years, the Joint Select Committee on Deficit Reduction still has no agreement to stem automatic cuts to the budget. At the current rate, Debtclock.org reckons that the U.S. debt will top $23 trillion in 2015, though the nonpartisan Congressional Budget Office puts the estimate at $17.6 trillion.
As incredible as it might seem, the U.S. dollar M1 money supply is currently up over 50% since the beginning of 2008. However, if you prefer to keep it closer, then it’s only up 17.5% since the beginning of 2011. At these rates, by 2015 perhaps a debt of only $17.6 trillion will somehow appear as “reduced” according to most any political measure. In the mean time, to diversify and protect our client’s assets against a further possible devaluation of the dollar and corresponding inflation threats, we will continue to scour the globe in search of higher yielding sound investments which may better protect and positively accrue wealth.
Turkey is a secular state often viewed as a bridge between East and West. With a constitution adopted in 1982 after a military coup, it is now a successful multi-party democracy. Prime Minister Recep Tayyip Erdogan has held office since 2003. Turkey’s financial sector has undergone a rapid transformation. Since the 2000–2001 financial crisis, the government has increased transparency, strengthened regulatory and accounting standards, and improved oversight. The Turkish economy has been Europe’s fastest growing economy in the last decade and has become the world’s 16th largest economy as of 2010.
While its traditional agriculture sector still accounts for about 30% of employment, an aggressive privatization program has reduced state involvement in basic industry, banking, transport, and communication, and an emerging cadre of middle-class entrepreneurs is adding dynamism to the economy. Turkey's traditional textiles and clothing sectors still account for one-third of industrial employment, despite stiff competition in international markets that resulted from the end of the global quota system. Other sectors, notably the automotive, construction, and electronics industries, are rising in importance and have surpassed textiles within Turkey's export mix. The government sets prices for many agricultural products and pharmaceuticals and influences prices through regulation, subsidies, and state-owned utilities and enterprises.
After Turkey experienced a severe financial crisis in 2001, reforms strengthened the country's economic fundamentals and ushered in an era of strong growth which averaged more than 6% annually until 2008, when global economic conditions and tighter fiscal policy caused GDP to contract in 2009, reduced inflation to 6.3% (a 34-year low) and cut the public sector debt-to-GPD ratio below 50%. Central government spending in the most recent year equaled 23.4 percent of GDP, while overall tax revenue as a percentage of GDP was 23.5 percent. Its well-regulated financial markets and banking system weathered the global financial crisis and GDP rebounded strongly up towards 9% in 2010, as exports returned to normal levels following the recession. The first half of 2011 experienced 9% GDP growth and rising inflation concerns.
Household consumption and private investment are considered the main growth drivers. Decreasing unemployment and ample credit availability are expected to prop up household consumption, which is reflected in the upward trend in the consumer price index. External demand is likely to remain subdued as the EU and U.K., Turkey’s main trading partners, are facing sluggish growth. Central bank governor Erdem Basci surprised investors in August by cutting the benchmark lending rate by 50 basis points to a record low of 5.75 percent. While this does raise inflation concerns, Basci has sought to control inflation by increasing bank reserve requirements to as much as 16 percent for the shortest-term deposits to limit lending and consumer demand. Reaching for alternatives to defend the lira when it tumbled to a record low against the dollar in August, the central bank spent about 10 percent of its $84.4 billion of foreign-exchange reserves in three months to buy the currency. Furthermore, Basci announced plans last month for dual lending rates to banks ranging from 5.75 percent to 12.5 percent, saying he may switch between them on a daily basis. The intent of these policies were to give him the flexibility that “no other bank in the world” has to strengthen the currency while retaining the option of cheaper money should Europe’s debt markets worsen.
Sitting third on the list of the world’s largest automotive manufacturers [behind Toyota (NYSE:TM) and GM (NYSE:GM)], the German luxury car maker Volkswagen sold over 7 million units in 2010 and constitutes such brands as Audi AG, Automobili Lamborghini Holding S.p.A., Bentley Motors Ltd, Bugatti Automobiles S.A.S., MAN SE, SEAT, Skoda automobilova a.s., Volkswagen, and heavy goods vehicle manufacturer Scania AB. Volkswagen Group is divided into two primary divisions: the Automotive Division, and the Financial Services Division. The Group consists of 342 Group companies, which are involved in either vehicle production or other related automotive services, and has about 450,000 employees worldwide.
Sales revenues for the first 3 quarters of 2011 were reported at over 116 billion euros, a better than 25% increase over the last year’s results. Operating profit was up €4.2 billion on the prior year figure, to €9.0 billion. Also note was that the planned merger with Porsche Automobile Holding SE would not be implemented, but that all parties remain committed to the goal of an integrated automotive group.
In August, rating agency Moody’s Investor Services raised its outlook for Volkswagen AG from “stable” to “positive” and held out the prospect of a rating upgrade in the next 12 to 15 months. At present, Moody’s has given Volkswagen a long-term rating of A3, and Standard & Poor’s rating is A-.
The default risk is Volkswagen Group’s ability to perform. Given its underlying strength and solid A3/A- ratings, as outlined above, it is our opinion that the default risk is significantly less than the currency risk of the Turkish lira.
The currency risk could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to the Turkish economy.
The strong economic recovery is attracting much (short term) foreign capital. About a third of Turkey’s external financing comprises short term debt, and the large influx of short term foreign capital could lead to asset bubbles. By nature, short term capital flows tend to be volatile, which is a risk in itself. Downward risk to the growth projections are present in the form of a sudden reversal of short term foreign capital flows and lower economic growth than is currently expected in the western countries. In spite of solid growth outlook, many global investors still consider emerging markets relatively risky. Turkey's relatively high current account deficit, uncertainty related to policy-making, and fiscal imbalances leave the economy vulnerable to destabilizing shifts in investor confidence.
Accessibility and Liquidity
Volkswagen maintains over $80 billion (USD equivalent) of various debt issuance programs in different countries and currencies. Rather that owning various emerging market funds and ETFs that blend together various winners and losers into a mixed yield cocktail and typically have no “maturity certain” date, we prefer our clients hold individual bonds with a specific maturity date. At times broker/dealers may require an institutional-sized single bond purchase, however, it is also possible for a number of smaller retail clients to be combined together in order to make a larger institutional sized purchase. Previously, we have been able to facilitate purchases as low as $5,000 U.S. dollars.
While there are increased concerns of overheating and inflation flaring up with an economy growing at over 7%, Turkey stands out as having successfully rebuffed a serious global economic crisis. By rebounding strongly in 2010, it appears to have decoupled itself from the rest of Europe and is well positioned as one of the economic leaders in the area. As a result of our consideration of these trends and the high yield in Turkish lira backed by a highly recognized and accredited industry leader, we believe this very short two year Volkswagen Group corporate bond in Turkish lira offers an exceptionally attractive opportunity for high yield income diversification, and it is why we have chosen to add it to our Foreign and World Fixed Income holdings.
- BB CUSIP: EI7087832
- Issuer: Volkswagen Financial Services
- Maturity: 12/16/2013
- Coupon: 8.50%
- S&P rating: A-
- Price: 98.63
- Yield to Maturity: 9.26%
Disclosure: Some Durig Capital clients currently own these bonds. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.