I recently attended a conference for institutional investors in Tel Aviv sponsored by DC Finance.. I came away with a better understanding of the Israeli institutional investment world and with some insights that may be of interest to independent investors no matter where they’re located.
Since Israeli banks are prevented by regulation from managing mutual funds or pensions, the main players in the Israeli institutional investment space are the large investment houses and insurance companies (Psagot, Clal, Migdal, Harel, etc.).
There are no beneficiary managed IRAs in Israel. All pension money is managed by investment houses in pension funds, so these institutions control most of the local investment capital.
The views of the analysts at the large investment houses ranged from bullish to bearish, but institutional investing isn’t about market timing. Institutional investors generally work within a set asset allocation framework, and their goal is to maximize return and minimize risk within that asset allocation.
Still there was much discussion about where the world economy is headed. People predicted a “back to basics” shift in finance – less leverage, less complex instruments and more careful risk analysis.
Leo Leiderman of Bank Hapoalim explained that the world has been getting very large doses of financial medicine and these will definitely have side effects. The medicine may also only be temporarily relieving the symptoms, not curing the disease. Government deficits and inflation are the most likely side effects. If these deficits are mostly due to a drop in tax revenues, then markets will react positively, but if the deficits are also a sign of increased government spending it will be a problem.
Regulation was a big topic and there was a lot of talk about increased regulation as a result of the crises. Yossi Bahar (former director general of the Finance Ministry) pointed out that regulation is not a magic wand – too much is as bad as too little.
Doron Tsur of Psagot, who had warned of the potential credit crisis before it broke, explained that predicting a crisis is easy; getting the timing right is the difficult part.
He said that central banks and governments are trying to inflate financial markets by brute force methods. So what you see on your computer screen doesn’t reflect the real world. He sees nothing in the real economy that supports the rally in world stock markets.
In equities, a few months ago there were companies selling for distressed prices. This is like getting a sick horse for a good price. This makes sense – if the horse gets better then I got a good deal. But today you are paying full price for a sick horse, which doesn’t make any sense.
A number of people saw a disconnect between the prices of stocks and bonds. Spreads are high, implying default rates that are not reflected in stock prices. This disconnect will have to resolve itself one way or the other.
The difference between the investment practices of institutions and individuals is shrinking. ETFs are not just used by retail investors; there is a sharp increase in the use of ETFs by institutional investors.
Despite the fact that Israeli markets have held up relatively well, it was agreed that there is a need to diversify more into global investments.
American institutional investors are also diversifying globally. The guest speaker at the conference, New York City Comptroller and candidate for mayor William Thompson, said that the NYC pension funds are investing more in international equity, private equity and real-estate. They also made their first investment in clean energy which he referred to as “only a first step”.
He explained that “we are long term investors. We try not to abandon strategies in place, but make subtle changes as needed along the way.”
Most Israeli institutional investors still see commodities as speculation. They are beginning to understand that they don’t have to be used this way. Commodity holdings could increase from the present near 0% allocation, once the institutional investor starts to understand how commodities work as an investment.
There is one last key point that I took away from this conference: Institutional investors need to get positive returns. Pension funds and Insurance companies have assumptions on minimal expected returns and they base their financial models on them. They simply will not keep money at near 0% interest for long. If interest rates remain this low, they will look for something to do with their cash to generate returns – they have no choice.
Many individual investors will behave in the same way. Even if cash is our best investment option now, we will convince ourselves that there is something better because we refuse to accept a 0% return. The difference of course is that we do have a choice.
Disclosure: No positions.