Israel ETFs’ Overlooked Potential

Israel is a rising developed market with emerging market growth potential, but chances are you don’t own it. 

Single-country investing isn’t for everyone. But when it comes to finding performance in single countries, Israel brings the stability of developed markets and the outsized growth potential of emerging markets, all in one, according to Steven Schoenfeld.

The founder of BlueStar Indexes, which underlie two of the four ETFs offering direct access to Israel’s story, has skin in the game, no doubt. But the bottom line is that Israel has some stellar companies delivering some stellar gains, and you might be none the wiser if you don’t at least stop to take a look.

ETF.com: Why should investors take a closer look at Israel?

Steven Schoenfeld: The short answer is because Israel’s economy and its companies are world-class. Israel is a leader in GDP growth, debt-to-GDP ratio, demographics. And Israel is home to scores of world-leading companies that otherwise wouldn’t be in investors’ portfolios.

That’s crucial. When Israel went from being an emerging market to a developed market in 2009 (by FTSE) and in 2010 (by MSCI), it went from being a medium-sized fish in the emerging markets lake to a tiny minnow in the developed markets ocean. Active and passive managers ignored Israel, because it became too small to matter. That’s part of the reason we started BlueStar in 2011. We felt Israel was going to get lost in the graduation, and we were right.

Israel is one of the best-performing economies among developed markets, but many of Israel’s best companies aren’t listed in Tel Aviv. They’re listed on the Nasdaq, NYSE, London, Toronto, Australia, Hong Kong and Singapore. You need a global approach to define the Israel opportunity set.

ETF.com: If you ignore Israel in your portfolio, what are some of the key stocks you’d completely miss out on?

Schoenfeld: Unlike the U.S. market, and unlike emerging markets, whether you use EAFE or the MSCI World ex-U.S. or the S&P equivalent or the FTSE equivalent, developed non-U.S. is very light on technology. From a sector perspective, adding an overweight to Israel within your developed markets helps bring up your tech exposure. For example, the Israeli tech as defined by BlueStar would represent 10% of the EAFE tech market cap even though Israel is only 0.47% now.

Companies like Check Point Software, one of the world’s leaders in cyber security; Wix.com, a leader in do-it-yourself websites and artificial intelligence; NICE Systems, one of the leaders in actionable intelligence and consumer intelligence; Amdocs, a leader in optimizing data for more than cellphone companies—if you take any disruptive technology, Israeli companies are at the cutting edge of it. And if you don’t make a dedicated allocation to Israel, you’re going to miss out.

Look at the performance of Israeli tech relative to the performance of broad Israel and relative to the performance of EAFE. Israeli tech was up about 28% last year; it’s up 14% this year.

ETF.com: If you plot the BlueStar Israel Technology ETF (ITEQ) versus the iShares MSCI Israel ETF (EIS), it seems the real performance opportunity is in Israeli tech, not broad Israel equities. Is that how investors should look at Israel—as a tech allocation? 

Schoenfeld: Yes and no. Technology is very strong in Israel, but for investors who look at country allocation, whether they’re using individual-country ETFs or they just think about the weights in non-U.S. markets, a good starting point is broad Israel. If you only look at tech, you miss exposure to Israel’s economy, which is a leader in the developed markets.

Israel’s one of the rare developed economies that has a young and growing population. It also has strong fiscal policies. It’s got a government that’s actively engaged in fostering innovation. Israel’s the best of both worlds. It’s got emerging market growth potential with developed-market stability.

For a technology-oriented investor, the case is less that you’re missing Israel, more that you’re missing great companies. Israel is the second-most-vibrant ecosystem after Silicon Valley; it has the most startups per capita; the most venture capital per capita. Yet most of these companies aren’t in investors’ portfolios.

ETF.com: What about risks associated with single-country investing? You’ve been known to say that technology is a geopolitical risk mitigator because you can’t shut down technology in case of such things as war. But what risks unique to Israel should investors take into account?

Schoenfeld: Israel is in a rough neighborhood. But Israel has learned how to mitigate this risk. In fact, developing defense technology has been one of the many edges of its tech industry. Israel’s overall economy—its industry—is minimally affected by geopolitics. And Israel’s geopolitical situation and its economic situation have never been better.

As former enemies and terrorist groups move closer to Israel, Israel’s diplomatic relations and economic ties have greatly expanded beyond trade with the U.S., Canada and Europe. Now Israel has huge trade relations with India, Latin America, Africa and Asia. More than a third of its trade and investment is coming from Asia, just as an example.

ETF.com: Some stats suggest the number of Chinese financial firms investing in Israeli tech companies doubled between 2013 and 2017. China could soon be the biggest investor in Israeli tech, surpassing the U.S. With the U.S.-China trade dispute unfolding, how much of Israel’s story is linked to what happens to China?

Schoenfeld: It’s linked in two ways. There’s the Chinese investment in Israel’s economy, which includes industrial, infrastructure, and even food and financial services investments. China wants to play a role in Israel’s growth, and it’s investing heavily in Israeli industries.

Connected to that is trade. Israel imports from and exports to China. That’s unlikely to be affected by U.S.-China trade tension. The U.S. has a free-trade deal with Israel. And Israel is negotiating free trade with China. So, trade isn’t going to be affected unless we have a major economic slowdown in the world, which would affect all the countries.

ETF.com: Let’s talk about performance. If you compare U.S. tech and Israel tech through ITEQ versus the Technology Select Sector SPDR Fund (XLK), ITEQ has underperformed XLK every year since 2014, but in 2018, they’re neck and neck. Why, and what’s the outlook? 

Charts courtesy of StockCharts.com

Schoenfeld: XLK is very large-cap U.S. tech. Israeli tech has underperformed relative to large-cap global tech, and large-cap U.S. tech.

But ITEQ has outperformed Israel more broadly. Driving ITEQ’s performance is leading companies, each with their own stories. Mellanox has had very good performance since late last year. Wix.com just keeps on delivering numbers, and it’s had great performance. Elbit System is both a cyber and a defense tech play, and defense tech has been very hot. The list goes on.

Israeli domestic investors have historically been missing their own tech rally, because these companies are listed predominantly in the U.S. In March 2017, things began to change when Intel made its largest acquisition ever of an Israeli company, buying Mobileye for $15.5 billion and at a 30% premium from its last listed price at the NYSE.

Most Israeli institutions didn’t have exposure, and that was a wakeup call for Israeli investors. Now, we’ve seen a steady flow of Israeli local interest into their own tech companies. This domestic inflection point is going to fuel a U.S. discovery factor, because people have seen the recent performance. ITEQ is now on the cusp of hitting that magical $50 million mark, which is going to get more advisors, more platforms comfortable with it.

ETF.com: Israel tech is outperforming broad Israel equity. China tech is outperforming broad China. Emerging market tech is outperforming broad EM. U.S. tech’s doing great. If you chase this performance, don’t you run the risk of having too much exposure to tech?

Schoenfeld: Yes. We do a monthly outlook on our Israel indexes, and the chart looks extremely bullish. Of course, all good things come to an end, which is why we often counsel people to look at broad Israel, which is still 30% tech.

It’s also why we define tech quite broadly. We include biotech, medical tech, clean tech, water tech, etc. But right now, I don’t think investors have too much tech in their developed international allocation.

Contact Cinthia Murphy at [email protected]