Why I'm Telling Clients to Avoid the Israel ETF

May.29.11 | About: iShares MSCI (EIS)

I am in the midst of a trip to Israel visiting current and prospective clients. Therefore, I thought it might be a good time to comment on the Israel ETF (NYSEARCA:EIS).

There is little doubt the Israeli economy is booming, its currency is strong, and Israeli companies have made tremendous accomplishments-- particularly in high tech. In fact, Israel is the only country that I can think of that was moved from the MSCI Emerging Countries index (ETF EEM) to the developed index (ETF EFA). The country also recently gained entry into the OECD.

But none of that necessarily argues for purchasing Israeli stocks, particularly not through the EIS iShares ETF. Here's why:

  • Overconcentration: Many cap weighted indices of small countries suffer from an over-concentration of holdings in a small number of companies, and EIS is no exception. 67% of its portfolio is in its top 10 holdings.
  • One stock, Teva Pharmaceuticals (NASDAQ:TEVA) is 21% of the Index. TEVA is a global pharmaceutical company. Its economic fortunes are not tied to the Israeli economy.
  • A large index weighting (27.8% highest of any sector) to Israeli financial companies. Israel emerged from the global financial crisis with its financial sector virtually unscathed. However, the high weighting to financials may not prove so profitable in the future.
  • The country is in the midst of a massive real estate boom and the newspapers are full of articles mentioning the "b" (bubble) word with regard to real estate. I am no expert on Israeli real estate, but I will say that by most valuation methods used for real estate around the world (rent:buy, months needed to accumulate a down payment, rate of increase in salaries: rate of increase in real estate prices), the market is very pricey.

The Israeli banks are conservative in their lending: no zero down or liar loans. The central bank has been raising rates and implementing regulation to discourage purchases of non owner occupied residential units. In most countries, a rising interest rate environment and a large retreat in real estate prices is not good for financials. An over-weighting in financials might not be the best way to invest in Israeli stocks.

  • Many rightly admire the Israeli economy for its accomplishments in the area of high tech. But the EIS has a very low weighting (7.67%) in these companies.
  • While I am not making a judgement as to whether owning Israeli technology stocks is a good idea, it is clear that there is no particular reason to buy stocks on the Israeli stock exchange in order to own these companies.
  • Israel is the second largest country in terms of non U.S. companies with listings on the U.S. stock exchange. 220 of these companies are dual listed between the U.S. and Israel.
  • The Tel Aviv stock exchange has a "blue tech" index of high tech companies. I did a quick check of the top ten holdings which make up 70% of the index. 8 of those 10 are dual listed and make up 60% of the index. Those interested in continuing the exercise can compare the index holdings to the list of Israeli companies that are dual listed.
  • Ironically, even for people that have the ability to buy stocks on the Israeli stock exchange, they are likely better off buying dual listed stocks on the U.S. stock exchanges. U.S. commissions and fees are lower and in many cases, certainly for a stock like TEVA, the liquidity during U.S. trading hours is better than during Israeli market trading. Keeping everything in one U.S. based account also simplifies matters with regard to tax management.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.