Why Israeli Tech Stocks Are ‘Underowned & Undiscovered’

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. He also was a founder of IndexUniverse, the predecessor to ETF.com.

Schoenfeld started the firm Blue Star Indexes with the ambition of developing benchmarks that go well beyond Israel, canvassing the entire eastern Mediterranean. Blue Star’s BIGI index is tracked in the U.S. by VanEck Vectors Israel ETF (ISRA), and Blue Star is the issuer of the U.S.-listed BlueStar TA-BIGITech Israel Technology ETF (ITEQ), which hit an all-time high earlier this month. ETF.com caught up with him to discuss Israel as well as Israeli tech stocks, and why he believes they are underowned and underappreciated.

ETF.com: There's a perception that Israel is in a bad part of the neighborhood, which is an added risk. As somebody who provides indexes based on Israeli equities, do you get that a lot? If so, how do you overcome that?

Steven Schoenfeld: When you think about where Israel is, obviously you have to be aware of geopolitical risk. Israelis certainly are. The overall Israeli economy has to deal with it and it has done that well. They invented technology to help you manage that risk.

Even though the broad Israel economy has certain sectors that are exposed more heavily to geopolitics, the tech sector in particular is the most separate from it. So if you think of tourism or banking or retail or some kind of manufacturing and things like that, those will be affected if there's more than a week or two of conflict.

But Israel's tech sector exports by basically clicking a mouse. Not all; some of it's manufacturing. And it's not just Israeli companies. Intel has a very major chip manufacturing fab there, too. But if the threat is from the south, from Hamas, they'll ship out of the port in the north, Haifa. If the threat is from the north, from Hezbollah, they'll ship out of the southern port, Ashdod. No country in the world is more prepared to deal with the economic fallout geopolitical risk.

Most of the time, we get this question in relation to the broad market. Our BIGI index is the underlying index for VanEck’s U.S.-listed ISRA ETF. There, you have a little more impact. But historically, the Israeli market is impacted not by the local regional geopolitics, which can be short term.

But the big moves—up or down—in the Israeli market are global economic. The tech meltdown in 2000/2001 affected Israel a lot more than the Gulf War of 2003. When you had the global financial crisis in 2008/09, that affected Israel more than the war with Hamas in 2008/09.

And almost invariably, when there is a short-term flare-up from some of Israel's enemies, invariably it ends up being a buying opportunity, for two reasons: One, the market, the foreign investors, overreact; and two, people forget that Israel has a very deep domestic investment industry—pension funds, insurance, mutual funds and ETFs. It's the tenth-largest ETF market in the world. If foreigners sell and push stocks down to a certain level of value, the domestic investors will buy it up. So there's a floor there.

ETF.com: I'm looking at ITEQ versus ISRA, and there's a huge outperformance there on ITEQ. Why is that?

Schoenfeld: The big differential that you see in ITEQ versus ISRA in the last year is partly because many of the leading Israeli tech companies who are leaders in their field—such as Check Point in cybersecurity, Mobileye in autonomous driving, Amdocs in automated recordkeeping and billing—they've been doing well; these are leaders in their field. And tech is still 34% of ISRA. The main reason ISRA has underperformed in the most recent period is not geopolitics, it's pharma, which had a big run-up in late 2014 all the way through the summer of 2015.

There was even a phrase for it: the "pharma drama." The two biggest stocks in ISRA are [pharmaceutical companies] Teva and Perrigo. So of course, if you look back at the first half of 2015, ISRA had a very good run. Then the air came out of that and Teva had some other problems. As the U.S. election campaign got going, you had politicians, particularly Hillary Clinton, talking about getting drug prices down. You had a number of factors that drove pharma down, and that was a drag on ISRA, especially relative to ITEQ.

Chart courtesy of StockCharts.com

ETF.com: When you describe the tech industry in Israel, what’s the sweet spot? Is there a focus there that's a little different than Silicon Valley, where you think of chips and Intel, social media and Facebook, search and Google?

Schoenfeld: For the most part, it's different. But since you mentioned Intel, one of the best ways to describe Israeli tech is "Israel inside."

For example, people talk about autonomous vehicles, and those cars will be BMW, Volkswagen; they'll be the name brands we know. But what's the technology that's going to be inside? It's going to be Mobileye. And many people may not know the Mobileye name, but it's there.

We all have cellphones. Well, AT&T and Vodafone and T-Mobile and Sprint and Verizon, as well as the biggest cellphone operators in Brazil and in Russia and in Mexico, all rely on the technology of Amdocs, an Israeli company. Think how complex it is for these companies to figure out everyone's bill. They're the leader in the systems and the software that enables that.

Schoenfeld (cont'd.): The other thing about ITEQ is that we are defining tech more broadly because Israel is also a leader in medical technology, in biotech, in clean and renewable energy, in sustainable agriculture and other things like that. We made it so that even though Israel’s a niche, it's actually very broad and very diversified in how we define tech.

The third and most important point is that, despite the leading role many Israeli companies play in all of the most innovative areas of technology, most existing tech indexes have minimal exposure to Israel. These are very important companies, yet they're not in most investors' portfolios. And some of it is purely sort of an accidental aspect of the rules of the existing index providers.

So we discussed Mobileye. Now, Check Point is in the Nasdaq, but Mobileye isn't. Why? It's listed on the NYSE, so, it doesn't get into the Nasdaq indexes. And because many of these companies aren’t American, even if they're listed on Nasdaq, they don't get into the S&P tech sector indexes.

Not only are these cutting-edge companies leading the world in some of the most transformative technologies, they're underowned and underdiscovered. And that's the core investment thesis for ITEQ—which is, Israel has well-known technology prowess, yet most investors are not focused on them. Or, at best, they have one or two of the companies, when there's 50 or more that one should consider.

ETF.com: So it, again, has nothing to do with the surrounding geopolitical risk?

Schoenfeld: My feeling is that it's lack of awareness more than the perceived political risk. Lack of coverage. There are only a few brokerage firms that have dedicated Israel technology coverage, or have more focus on it within their broad tech.

And because so many of Israel's tech leaders are not listed on the Tel Aviv stock exchange, they're not in the domestic benchmark of Israeli institutions. So they're underowned in the domestic market.

This is beginning to change. Israeli domestic investors—especially pension funds and insurance companies—have noticed the outperformance, and they're starting to figure out ways to do it. There are products listed in Israel that track our index that can help them get exposure to it.