Israel Trails World Index as Upgrade to Developed Market Forces Out Buyers

Investors speculating Israel stocks would benefit after MSCI Inc. raised the country to developed status two months ago are still waiting for the rally.

The TA-25 Index is up 1.7 percent since Israel left the MSCI Emerging Market Index on May 27. That compares with gains of 4.3 percent in the MSCI World Index and 9.6 percent in the developing-countries gauge, data compiled by Bloomberg show.

While the upgrade spurred optimism as Israel was ranked alongside the U.S., Germany and Japan by MSCI, it means fewer funds are paying attention to its companies. Israel accounts for 0.36 percent of the developed country measure, compared with 2.9 percent of the MSCI EM Index. Funds may have been slow to buy Israeli shares because of its smaller weighting, according to Delaware Investments, Van Eck Associates and BlackRock Inc.

“It became a tiny fish in a much bigger pond,” said Bruce Schoenfeld, the Boston-based vice president at Delaware Investments, which manages $135.6 billion. “Because Israel is such a small weight, it can safely be ignored by portfolio managers without taking much risk. I’m sure there was also probably a certain amount of selling on the part of dedicated active emerging markets investors.”

Blackrock Inc.’s $2.8 billion iShares MSCI World Index exchange-traded fund, which tracks the benchmark gauge, has 0.3 percent allocated to Israel. Buying stocks in smaller countries may be too costly for index trackers, said Nizam Hamid, head of sales strategy for iShares.

‘Cost Effect’

“There is a trade-off between having full replication of the index as opposed to the cost effect,” said Hamid. Smaller companies may be overlooked to avoid using resources on “stocks that are unlikely to affect the overall performance,” he said.

Robeco Investment Management’s Global Equities fund, which uses the MSCI as a guide, doesn’t hold any shares in Israel, according to its latest filing. Rotterdam-based Robeco manages $194 billion, according to its Web site.

“We abandoned Israel stocks after they were promoted,” said David Semple, a portfolio manager at New York-based Van Eck, where he helps manage $22 billion. His emerging-markets fund has beat 96 percent of its peers in the past year. “There are a number of interesting companies there, but as they’re off our index now and don’t appear to have significant upside to fair valuations, it has not been a focus.”

Citigroup Inc. estimated in March that $2.8 billion from index-tracking funds would pull out when Israel was reclassified and $3.6 billion would enter. While global funds may use MSCI’s classification as a guide for where to invest, they are not always required to duplicate the company’s weightings.

First Upgrade

Israel was MSCI’s first upgrade since Greece in 2001. The Athens Stock Exchange General Index underperformed the Stoxx Europe 600 Index by 7 percentage points in the 12 months following the promotion on May 31 that year.

Jacob De Tusch-Lec, whose London-based Artemis Global Income fund was introduced July 19, is “overweight” Israel stocks.

“Israel came through the recession and the big financial crisis far better than most developed markets yet the country is trading at rather low relative levels,” said De Tusch-Lec, whose fund owns shares of Mizrahi Tefahot Bank Ltd., Israel’s third-largest lender, and Bezeq Israeli Telecommunication Corp., the biggest communications company. “Investors are not giving the country the credit it is due.”

Export Powered

Israel’s economy will expand about 3.6 percent this year, the Finance Ministry said June 6. That’s higher than forecasts for 3.1 percent growth in the U.S. and 1.1 percent in the euro area this year, according to median economist estimate in a Bloomberg survey.

The TA-25 reached a record on April 6. The benchmark gauge rose 30 percent in the 12 months following the June 15, 2009, announcement from MSCI that it would upgrade the country.

Stocks in the index trade at 12.4 times estimated earnings for the next 12 months, 42 percent higher than the Stoxx Europe 600 Index, according to data compiled by Bloomberg.

“The guys who follow the emerging markets index say let’s reduce this allocation because the other guys are going to be picking this up,” said Wasif Latif, vice president of equity investments at USAA Investment Management Co., which oversees $45 billion in San Antonio. “That generally means that you may not get the kind of attention and focus from the folks who are dedicated to your market as you had in the past.”

To contact the reporters on this story: Alexis Xydias in London at axydias@bloomberg.net; Ronit Goodman in Tel Aviv at rgoodman@bloomberg.net.

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