Efficiently Accessing The Companies Behind Israel's Dynamic Economy

Jun. 13, 2013 8:24 AM ETCHKP, CSTE, DOX, EIS, MLNX, NICE, PAY-OLD, SODA, TEVA, VRNT7 Comments
Steven Schoenfeld profile picture
Steven Schoenfeld

This column encapsulates recent BlueStar Global Investors research. More information on the company, the author and research contributors follows. The author of this article, Steven Schoenfeld, is the founder and CEO of BlueStar Global Investors, LLC. which developed the BlueStar Israel Global Index.

Israel has one of the most dynamic, innovative and resilient economies in the world: it's home to some of the world's largest healthcare and industrial companies, a well-capitalized financial sector; leading companies in high-tech, bio-tech, defense-tech, and agri-tech and the largest natural gas discovery in the past decade.

The country's strong economic prospects and the performance of its world-class companies resulted in Israeli equities outperforming U.S. equities more than five-fold over the past two decades. Yet many foreign investors are significantly under allocated to Israeli stocks. Israel presents an attractive investment opportunity for individual and institutional investors alike, but unfortunately, there are major structural problems facing the Israeli capital markets which make a portfolio allocation decision toward Israeli equities complex and challenging for foreign investors. These challenges include: liquidity and regulatory issues with the local exchange, substantial cross-holdings amongst Israeli corporate 'pyramids,' and Israel's small weight in developed market indexes.

Compounding these challenges, the most prominent Israeli equity benchmarks and the investment vehicles that track them fail to represent the complete universe of Israeli stocks. They don't capture the full dynamism of Israel's global economy and are thus suboptimal benchmarks. Mellanox's (MLNX) impending delisting from the Tel Aviv Stock Exchange - and its removal from the local TA-25 benchmark this coming Sunday -- highlights this issue. But the problem has long been evident-- some of the most successful Israeli companies -- including Check Point Software (CHKP), SodaStream International (SODA), VeriFone (PAY), Amdocs (DOX), CaesarStone (CSTE), Verint Systems (VRNT), and many more -- are missing from the major Israel equity benchmarks, whether calculated by the TASE, MSCI or FTSE. The resulting lower index market capitalization reduces Israel's weight in global benchmarks like MSCI EAFE and FTSE All-World, reducing the country's visibility to foreign investors.

Thus, investors using established benchmarks to guide their allocation to Israeli equities are left with choices unrepresentative of the true size and scope of the Israeli equity universe, making Israeli equities look like a less attractive investment than they really are. But a solution to this market dissonance is relatively straightforward: the adoption of a "better benchmark" for Israel, namely the BlueStar Israel Global Index ("BIGI"). BlueStar developed BIGI two years ago in consultation with sophisticated US endowments & foundations, and will be licensing it for a US-listed ETF later this month.

What follows is background on the challenges of properly defining and benchmarking Israeli equities and the "BlueStar solution," along with some observations about Israeli equity performance. I also provide technical analysis of Israeli Global Equities using the BIGI benchmark, based on the monthly research done by BlueStar Global Investors and available on http://bluestarindexes.com/.

The Problem: Inefficiencies in widely-used Israeli equity indexes

Portfolio managers who want to make the proper allocation to Israeli stocks in the context of a developed market equity portfolio have limited choices of how to execute. Most Israeli equity indexes, including the local TA-25 and TA-100 benchmarks, and the MSCI Israel and (the MSCI Israel Capped Index is tracked by EIS (EIS)) and FTSE Israel indexes used by foreign investors, all have a high weighting in TEVA and a relatively high concentration in the top ten constituents. If a fund manager wants to implement an Israel allocation within their portfolio, they can do so by simply buying shares of Teva (TEVA), Israel Chemicals, Bank Hapoalim, Bank Leumi, Bezeq, NICE Systems (NICE), and Mellanox. And now that Mellanox will no longer qualify for inclusion in most Israel equity indexes, the options for investing in an Israel index-tracking fund are even less enticing; why pay management fees when you can simply buy and hold the shares of just a handful of the biggest companies and achieve barely decreased diversification risk but acceptable correlation to the benchmark?

Comparative Index Concentration

SOURCE: BlueStar Global Investors, LLC.

May 31, 2013

The other problem in the aforementioned indexes is encapsulated by this evolving fact: Mellanox's foregoing absence in the most prominent Israeli Indexes makes the company no less Israeli and no less linked to the Israeli economy. The removal of Mellanox from the most prominent Israeli equity benchmarks is a classic example of how these indexes fail to represent the complete Israeli Equity Universe - - which the BlueStar Israel Global Index has been designed to achieve.

The solution: The BlueStar Israel Global Index ("BIGI")

BIGI resolves the fundamental flaws in existing Israeli equity indexes: diversification and completeness. BIGI's diversification parameters cap the highest weighted constituent at 12.5% and the combined weight of all components with a weight of 5% or more do not comprise more than 50% of the index. More importantly, the BlueStar index includes all eligible Israeli companies regardless of their listing venue. If one believes the exclusion of Mellanox (market capitalization just over $2 billion) in TA-25 and TA-100 Indexes and the MSCI Israel Index is a big deal, try multiplying that by a factor of fifteen! The combined market capitalization of Israeli companies excluded from other Israel indexes due to their listing venue totals over $30 billion in the top ten constituents of BIGI alone. To put that figure in perspective, compare BIGI with the index market capitalizations in the table below.

"Missing Market-Cap"

Comparative Index Market Capitalization

An additional result of this global approach to benchmarking Israeli equities is that the BlueStar Israel Global Index appropriately weights Israel's robust technology sector. Ironically, the benchmarks used for the "Start-Up Nation" by the vast majority of domestic Israeli asset managers and global investors dramatically under-weight the tech sector. Many of Israel's world-renowned technology companies list their shares exclusively in the U.S. (NASDAQ or the NYSE and not the TASE) and are therefore rendered ineligible for inclusion in most currently-used indexes such as the TA-25 and MSCI-Israel. The Mellanox delisting highlights the need for a truly global approach for benchmarking Israeli stocks and/or implementing an index-based Israel equity allocation.

Israeli Equity Benchmark Comparison

SOURCE: BlueStar Global Investors, LLC.

May 31, 2013

Bigger Opportunities in a Broader Universe - "Israeli Global Equities"

The generally lower level of institutional coverage of some of the constituents of the BlueStar Israel Global Index presents inefficiencies which are exploitable. Although Mellanox does not lack in institutional coverage it provides an instructive case study: The stock price began falling (again) in June, this time mostly for structural rather than fundamental reasons. Therefore, we believe that, eventually, analysts and investors who know the company well --and perhaps the company itself -- will be willing to buy the shares at substantially lower prices. In my next column we'll delve a bit deeper into specific stock and sector opportunities.

Just as lower levels of institutional coverage create fundamentals-based stock opportunities, so too does technical analysis on a well-designed, comprehensive index for Israeli global equities. The patterns and chart levels I describe below have guided our firm's tactical and strategic outlook for Israeli equities over the past several months and quarters (and thus I use the term 'we' below). Past months' analyses are available at bluestarindexes.com.

Israeli Global Equities began to rebound (led by the financials and energy sectors) after putting in three-year lows in mid/late 2012. After breaking important trend lines in November 2012 - during Israeli Global Equities' rebound from the sharp drop at the beginning of Operation Pillar of Defense in Gaza - BIGI consolidated in December and resumed its upward movement in January and February. The market sell-off during Operation Pillar of Defense to the 200 index level for BIGI confirmed that this is a significant medium and long-term level of support for the index.

BIGI is now consolidating (see chart 1A) following the rebound from mid-2012 just described. The range is depicted by the dotted green and red lines and for now, the range is occurring within the context of an upward trend. The 100-day SMA (simple moving average) in chart 1B seems to be quite significant as indicated on the chart below. We believe that, so long as that average is held and the 30-day SMA does not decisively cross the 100-day SMA, the chance of a breakout to the upside following this period of consolidation is greater than the chance of a breakout to the downside. At this point, we are comfortable saying that 229-230 has been confirmed as support at the lower end of the above-described range.

Chart 1A

Source: BlueStar Global Investors LLC

(Jan 1, 2010- May 31, 2013)

Chart 1B

Chart 2A

Chart 2B

If the lower end of the range is broken we would look for the lower band of the upward channel, just above the 220 level, to be the first level of support and a soft stop-loss level, followed by the 200 level being our hard "stop-loss" level.

The longer-term outlook for Israeli equities continues to be firmly bullish as the index has re-entered the channel connecting the 2008/2009 lows (see chart 2A which spans the entire 2008-2009 global financial crisis). On that chart, the 50-day SMA may have gotten too far ahead of the 200 day SMA; it is perfectly normal to see consolidation or even a pull-back in the short term. The longer-term outlook will become even more bullish if Israeli Global Equities decisively breaks through the upper band of this channel which has crept up to the 240 level: we see the projected upside potential, in that case, of the index to be at the 300 level by the end of 2013, though most likely following a break at the resistance level of 250-260) and a consolidation at the 2011 high of 275.

For the longer-term investor, if the 230 and 220 levels are breached and then confirmed with a weekly close of BIGI below 195, the longer-term outlook will shift dramatically, any rallies should be sold. In that case we would project a major decline to around 135. Our baseline view is that the index is going higher in the medium to long term and though the 236 level has been breached as of this writing, given volatility in global equities, and bearishness in key emerging markets, near term downside risks are making their presence felt.

For more information check out the author's and research contributor's bios here.

Disclosure: I am long EIS, CHKP, MLNX, NICE, PAY, DOX, CSTE, VRNT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: BlueStar Global Investors, LLC. is an index and research provider. An affiliate of BlueStar Global Investors, LLC. is generally long EIS and the stocks mentioned in this article. BlueStar Global Investors, LLC. has developed the BlueStar Israel Global Index and will be licensing the index, for a fee based on AUM, in the future.

This article was written by

Steven Schoenfeld profile picture
BlueStar Global Investors LLC is a financial information and research firm with expertise in the Israeli and the broader Middle East and Mediterranean capital markets. Our initial focus is on Israeli stocks trading worldwide, but our research efforts span public equity, private equity/venture capital, fixed income, mutual fund and absolute return strategies. Our mission is to develop investment strategies that provide global institutional and retail investors with efficient access to the full range of Israeli asset classes. Steven Schoenfeld is the company's founder and CEO.
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