Israel: An Often Overlooked Outperformer

September 01, 2015

Steven Schoenfeld is one of the index industry’s most knowledgeable figures. His classic tome, “Active Index Investing,” published in 2004, is a must-read for any die-hard indexing fan. Schoenfeld also started the firm Blue Star Index with the ambition of developing benchmarks that go well beyond Israel, canvassing the entire eastern Mediterranean. While that dream is predicated on hopes for peace in what is a dangerous neighborhood, it’s hard to deny that the payoff could be big for investors with an appetite for risk and an awareness of how successful Israel’s economy already is.

ETF.com: Why are Israeli stocks outperforming U.S. markets this year?

Steve Schoenfeld: Israel is a developed-market economy and a developed stock market by MSCI, FTSE, OECD standards. But it's physically located in a pretty rough neighborhood. And because of that, it's often overlooked by investors, both institutional and retail.

In addition, because of the chaos of the Middle East—historically—but especially since 2011 and the Arab Spring, Israel has been surrounded by turmoil. Whether it's changes of government in Egypt, the rise of ISIS or the collapse of Syria in civil war, Israel has constant threats on its border, whether it's Hezbollah or Hamas. When you think of political risk, Israel seems like a risky place.

However, the fact is that Israeli companies are world-class. Hundreds of Israeli companies are doing business all over the world, having very profitable and robust franchises, and innovative products. When you look at Israel as a market and as an investment, it's actually quite attractive.

If you look at the past five, 10, 15, even 25 years, despite all the challenges of Israel's geopolitical location, the Israeli stock market has performed well, and has produced absolute and relative returns that are very favorable for U.S.- and European-based investors.

The problem is the headline that Israel often feels risky. But investors need to dig in and look at the actual companies. If you look at the top 30 Israeli companies, these are leaders in almost every key sector—health care, information technology, telecom, consumer discretionary and consumer staples. There are also strong emerging technologies, whether it's cybersecurity, online ad tech, defense tech, agri tech. Look across the innovative sectors of the world and you find many Israeli companies.

Chart courtesy of StockCharts.com

ETF.com: That diversity obviously is helping economic and market performance.

Schoenfeld: Yes. When Hamas started a battle with Israel last summer, tourism, banks and hotels got hit, but Israel's export prowess wasn't hit at all. In fact, at the end of last summer, Israel had one of its most successful IPOs—Mobileye—which is the world's leader in autonomous driving. When you think about self-parking cars or eventually self-driving cars, it's an Israeli company that’s at the forefront.

In addition, all the world's tech leaders—like Google, Microsoft and Apple—have their biggest R&D centers outside of their home market in Israel. They tap into the innovative, entrepreneurial tech ecosystem that is Israel. The country has more venture capital per capita and more startups per capita than anywhere else in the world.

The Israeli market and economy is diversified. It's robust. And unfortunately because of the neighborhood that it's in, it's resilient. Israeli business has learned to deal with the inevitable ups and downs of the geopolitical situation. Israeli companies are known as reliable partners, even when there’s some tension in the region.

ETF.com: Let's talk about Israel through the ETF lens. Your firm provides the index for the Market Vectors Israel (ISRA | C-26), which launched in 2013. The first U.S. ETF to the space was the iShares MSCI Israel Capped (EIS | C-58). Can you speak to the differences between the funds? For instance, EIS is heavy on Israel-based companies—almost 99 percent of the underlying companies—while ISRA is Israel 57 percent, followed by 40 percent in the U.S.

Schoenfeld: [Blue Star] looked at the issue of country classification and company classification. Do you attribute a company to where it's listed or to where it’s headquartered? BlueStar built a pretty sophisticated methodology that looks at qualitative and quantitative factors that define an Israeli company.

The goal, very simply, was to be broad, deep and complete in defining what is an Israeli company, and then, of course, applying liquidity screens, minimum market cap and all the best practices of index design.

As a proportion of its market, Israel is very impacted by this issue of domicile. Some of the biggest and best Israeli companies are either dual listed—such as [pharmaceutical firm] Teva, which is traded in the U.S. as well as in Tel Aviv—or listed abroad. The best example of that would be Check Point Software.

Check Point literally was the company that developed the term "firewall." The company is legally registered in Israel. It pays taxes in Israel. It's headquartered in Israel. But because it's a tech company, the company went public on the Nasdaq in the U.S.

You have dozens of Israeli companies that have followed in those footsteps. Mobileye is headquartered in Jerusalem, all the intellectual property is domiciled in Israel, but it went public in the U.S. It wanted to get the analyst coverage and the visibility.

You also have a number of Israeli companies going public in London. These companies are no less Israeli than a company that’s based in Israel but happens to be listed in Tel Aviv.

We broke this artificial divide of listing exchange versus where the company is based. We used some very sophisticated criteria, both quantitative and qualitative, to have a robust framework on what is an Israeli company. The end result is an index that’s broader, deeper and more complete, and most importantly, fully representative of the Israeli economy.

ETF.com: What are some of the financial problems facing Israel? What is its monetary policy?

Schoenfeld: Israel has an enviable position of having to worry about its currency—the shekel—being too strong. If ever the central bank intervenes, it's often to keep the shekel weak. The Israeli market actually is correlated more with global markets than with all the small and medium-sized geopolitical risks in the region.

That said, there's always the risk of hostilities. If Hezbollah or Hamas decide to start a conflict, it can affect the domestic economy. It definitely affected the local economy last summer.

If Iran, as part of its efforts to establish hegemony in the region, decides to encourage Hezbollah to attack Israel, it absolutely can affect the market in the short term. Historically, these dips have been dips to buy on. That is just the way the economy has been set up.

There are other risks. There are risks of strikes. Even though Israel is very much a capitalist economy, it was started as a sort of utopian labor socialist country back in the '40s and '50s, so the labor unions have strong power.

But right now on the horizon, we don't see major economic risks. Obviously, if China's growth slows down, emerging market growth slows down as well, and these have become more and more important markets for Israel.


Contact Cinthia Murphy at [email protected].

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