Israeli portfolio managers look outward and sideways

With low returns on conventional investment strategies, the portfolio managers who took part in a panel at the Globes Israel Business Conference are investing more overseas and in nonfinancial assets.

By RON STEIN
Money 311 (photo credit: Bloomberg)
Money 311
(photo credit: Bloomberg)
The stock market is at a peak, yields on both government and corporate bonds are at a trough, and interest rates are still low. These are the problematic starting points that investment managers have to cope with today, after a strong bull market that began in 2009 and has continued until now.
Looking ahead to 2011, Globes brought together a panel of investment managers from the main investment institutions at the Israel Business Conference. Altogether, they manage more than NIS 440 billion. The aim of the panel was to examine the challenges they face and to give private investors guidance on the right way to manage a portfolio today.
The panel members were Gilad Altshuler, owner and joint CEO of the Altshuler Shaham Group; Gady Greenstein, chief investment officer at Israel Phoenix Assurance Ltd.; Amir Hessel, deputy CEO of Harel Insurance Investments and Financial Services Ltd.; Yoni Tal, deputy CEO of Menorah Mivtachim Holdings Ltd.; Roy Yakir, CEO of Canaf, the investment arm of Clal Insurance Enterprises Holdings Ltd.; Gili Cohen, chief investment officer of Excellence Investments Ltd.; Rafi Kessel, investment manager at Analyst IMS Investment Management Services Ltd., and Omer Kreisel, who manages policy holders’ investments, real estate and hedge funds at Migdal Insurance and Financial Holdings Ltd.
INVERTED RISK PYRAMID Globes: What should people do today: increase their risk, or limit their return? Cohen: “The risk pyramid today is inverted. The level of P/E [price-to-earnings] ratios favors investment in stocks, which looks more correct at the moment, with the bond market, which is overpriced, coming after it.”
How should the state of the bond market affect the distribution of investments in customers’ portfolios? Yakir: “We have to call a spade a spade. There’s a problem in the market, and we are looking to buy alternatives.
But that is no substitute for what we were familiar with in normal times. This means raising risk or limiting returns.”
Tal: “There’s no doubt that between government bonds and high-rated corporate bonds on the one hand, and more risky instruments on the other, the allocation of assets is biased more in favor of the riskier assets. This means not just stocks, but also real estate, mezzanine investments and so on. These components will grow as a proportion of the portfolio.”
On the other hand, the stock market is very high.
Hessel: “The potential in stocks is still there, for one thing because of the improvement in profitability and in relative prices, and for another because firms are benefitting from very low financing costs. The potential for bonds is more interesting, and it will be interesting to see how a rise in bond yields, when it happens, will affect stocks.”
Yakir: “As far as the local stock market is concerned, given the low rates of interest and reasonable stock prices, people should certainly be in there.”
Tal: “In the local market, it is fair to say that firms are in a good position and cash rich, they are stressing liquidity and caution, and their P/E ratios are low. However, there is a risk that cannot be ignored, to do with the fact that a problem is developing of deficits, the like of which we have never seen in Europe and the US, and I don’t know how that will affect companies.”
Kreisel: “Interest rates in the US will not rise all that fast, and we have come to the conclusion that the share component still offers good prices, despite the rises over the past two years. I see no justification for investing in government bonds of developed countries, because of the low interest rate.”
Greenstein: “If there is room for risk taking in the portfolio, it’s in equities and not in debt, and that’s all the more true overseas.”
Is it worthwhile investing more overseas? Kessel: “We don’t feel that we understand enough to invest in Irish bonds. We like investing in what we know, and we can find investment opportunities in Israel. We have learned that if there are no opportunities in the market, you should wait for them, and prices will eventually come down.”
Greenstein: “Although Israel is our comfort zone, the overseas component of our investments is growing all the time.”
Altshuler: “For a long time, we have had a 40 percent overseas exposure. This is for several reasons: It’s risky to be solely in Israel, or to hold a very high proportion of assets here, when the advantages that there were at one time in the local market no longer exist. Secondly, there is certainly room for overseas exposure in the bond portfolio. You don’t have to be in the PIIGS countries; there are good countries like Canada, Australia and Finland.
“Thirdly, if there’s a crisis here, everything will collapse and there will be many opportunities, and then it will be possible to bring money back from overseas and buy extremely cheaply. Furthermore, there’s a problem of size in the local market – the Israeli institutions are already too big for the market – and overseas the liquidity is something else entirely.”
Hessel: “We have to keep increasing investments overseas.
Pricing in the Western European and US markets is lower than in the Israeli market. Take, for example, Walmart versus Shufersal; Shufersal is traded at a higher P/E ratio, while Walmart is growing faster. In general, the markets overseas, in Western countries, are at interesting price levels compared with Israel.”
Which other instruments do you find interesting at the moment? Hessel: “We have found alternatives in infrastructures and real estate, in Israel and overseas, in credit and in PE [private-equity] deals. As long as basic conditions on the capital market remain unchanged, we will do more of these deals.”
Incidentally, it seems that in recent years more and more of the large institutions have also become income-producing real-estate companies. Why is that? Hessel: “The spread between corporate bonds and real estate is now perhaps at its largest in 20 years, or even more. In the with-profits portfolio, we are already at 6% real estate, and still far from the limit at which we will stop feeling comfortable.”
Greenstein: “All over the world, portfolio managers are grappling with problem of low returns, and so the rush to attractive sectors like real estate is common to institutions worldwide, which brings in train a rise in the prices of the assets they are looking for. But they still offer a surplus return in relation to other sectors.”
Does the growth in alternative investments stem from the situation of normal instruments, or from a long term view? Kreisel: “You have to look at it from an economic point of view, not because of the return but because of the value. In the past, too, we knew when to go for nonfinancial assets, such as income-producing real estate.”
Cohen: “At a certain stage, an alternative can be a trap. Every time there are no returns – and we look for somewhere that does produce returns – it could be that the right choice is to sit on the sidelines and wait for an opportunity. As long as the world is flooded with money, it’s possible to opt for alternatives. But you have to remember that that will come to an end. We are certainly not in a normal world, and you have to look to the day after. There will be real consequences, such as inflation.”
INSTITUTIONS BECOME MORE VARIED Many people argue that when it comes to managing assets in an institution, the guiding principle is largely not to be caught in a corner. Not out of pure portfolio-management considerations, but also (and in some institutions, mainly) out of marketing considerations and the fear that returns in the market will leave them behind.
“Part of the reason that many institutions don’t venture overseas is the benchmark,” Altshuler said, adding, “Many institutions look sideways, wanting to take the step, but unable to.”
How far does the competitor’s portfolio represent a consideration for you in building your own portfolio? Greenstein: “Anyone who looks at the institutional table sees that the herd mentality has considerably weakened in recent years, and the variations between the leading institutions are growing. In the past, keeping an eye on the competitors and the place in the returns rankings was more important.”
Kreisel: “At the end of the day, most institutions are looking ahead in the search for opportunities. Today, you see variety and different initiatives, in contrast to the past.”
FISCHER IS ONLY GAINING TIME A controversial phenomenon on the capital market is the intervention of Bank of Israel Governor Stanley Fischer in the foreign-exchange market. Since the Bank of Israel began buying dollars, Israel’s foreign-currency reserves have jumped from about $28b. before the crisis to some $70b. today.
Fischer told Globes, “I shall continue riding on the back of the tiger until it stops being a tiger and becomes a horse.”
Fischer sees no problem in the size of the foreign-currency reserves, and he argues that the special situation of the Israeli economy makes his continued intervention necessary.
Most of the panelists thought that Fischer could not affect the appreciation of the shekel over time.
“Fischer’s actions are naive,” Yakir said. “The purchases will not affect the shekel, which will continue to behave like the rest of the world’s currencies. Fischer is only gaining time.”
“Fischer is in a trap,” Hessel said. “The interest rate here is too low in relation to the situation of the economy, and it has to rise, even though the interest rate in the US will not rise all that fast. The trend bringing foreign money to Israel will continue, even stronger. Fischer’s activity creates distortions and invites institutions to trade in the shekel, and that can’t continue. A tax should be imposed on short-term activity by foreign players. That will help solve the problem of the appreciating shekel.”
“In any event,” Kreisel said, “because of the printing of dollars, there is a small chance of the shekel weakening.
Inflationary forces in the local market will probably lead to a higher interest rate in Israel, which will add to the attractiveness of the shekel and to the inward flow of money. It is therefore necessary to deal with capital movements into the local market.”
According to Kreisel, the question is what will happen when Fischer stops intervening.
“Fischer is trying to stop the shekel and gradually to accustom firms to a strong shekel,” Altshuler said.
“Fischer is trying to gain time and give firms space in which to streamline and change their mix,” Cohen said.
On the other hand, Kessel and Tal believe that having a few dollars more is not such a great disaster.
“For me, it’s actually comforting and pleasant to hear that Israel’s reserves are growing: that this remote, tranquil island continues on its way,” Tal said. “It’s good that there is growth in the reserves, and it has economic value.”
“The great problem is when there aren’t enough dollars, as happened in 2002,” Kessel said.