ISRA - VanEck Israel ETF: Uninvestable In The Current Environment

2023-11-03 12:00:00 ET

Summary

• The VanEck Israel ETF faces several risks that make it uninvestable in the current climate.
• Short-term economic shocks, including a potential economic downturn and operational challenges in the tech sector, are negatively impacting the Israeli economy.
• Long-run economic uncertainty, such as potential emigration and demographic shifts, poses a risk to the Israeli economy.
• There is a credible risk of the conflict escalating towards a broader regional or global conflict, which should be enough to avoid investing in ISRA.

Disclaimer: In this article, I argue that the VanEck Israel ETF (ISRA) faces several risks that make it uninvestable in the current climate. I have made every possible effort to keep this analysis apolitical. Nothing I have written below should be construed as an opinion or judgment about the political, social, humanitarian, or military situation in Israel.

Fund Description

The VanEck Israel ETF "seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the BlueStar Israel Global IndexTM (BLSNTR), which is comprised of equity securities, which may include depositary receipts, of publicly traded companies that are generally considered by the Index Provider to be Israeli companies."

The USD-denominated fund, which trades on the NYSE Arca, has ~$48MM of net assets and a gross and net expense ratio of 0.64% and 0.59%, respectively. In the charts below, you can see the portfolio breakdown by sector and country.

The fund's top 15 holdings can be seen below.

The fund's top 15 holdings account for ~62% of NAV (n.b., top 15 sector breakdown is ~52% IT, ~27% financials, ~10% healthcare, ~8% industrials, and ~3% TelCo). Brief descriptions of the top 10 holdings (n.b., ~51% NAV) are provided below.

Check Point Software Technologies Ltd: American-Israeli multinational provider of software and combined hardware and software products for IT security, including network security, endpoint security, cloud security, mobile security, data security and security management.

Teva Pharmaceutical Industries Ltd: Israeli multinational pharmaceutical company with headquarters in Tel Aviv, Israel. It specializes primarily in generic drugs, but other business interests include active pharmaceutical ingredients and, to a lesser extent, proprietary pharmaceuticals.

Nice Ltd: Israeli technology company specializing in customer relations management software, artificial intelligence, digital and workforce engagement management solutions.

Amdocs Ltd: Founded in Israel and currently headquartered in Chesterfield, Missouri, with support and development centers located worldwide. The company specializes in software and services for communications, media and financial services providers and digital enterprises.

Bank Leumi Le-Israel Bm: Bank Leumi is a major Israeli bank offering a comprehensive range of financial services including personal and corporate banking, private banking, and asset management to customers both domestically and internationally.

Bank Hapoalim Bm: One of the largest banks in Israel, established in 1921. The bank offers a broad range of financial services to retail, corporate, and institutional customers, with a focus on retail banking services. It operates a network of more than 250 branches and offices in Israel and abroad.

Cyberark Software Ltd: Information security company offering identity management. The company's technology is utilized primarily in the financial services, energy, retail, healthcare and government markets.

Elbit Systems Ltd: Israel-based international defense electronics company engaged in a wide range of programs throughout the world.

Mizrahi Tefahot Bank Ltd: Third-largest bank in Israel. It has around 140 branches. The bank is the largest among Israel's mortgage lenders.

Israel Discount Bank Ltd: Retail bank, commercial bank, private bank and financial services company headquartered in Tel Aviv with 112 branches throughout Israel.

Key Risks

1) Multi-Faceted Short-Term Economic Shocks

This section discusses the risks to the Israeli economy and, therefore ISRA, which are non-speculative. The negative developments below have already manifested and are unlikely to resolve for the duration of the highly kinetic phases of the war.

On October 30, the Times of Israel reported a cohort of ~300 distinguished economists urged Prime Minister Benjamin Netanyahu and Finance Minister Bezalel Smotrich to curtail all non-critical state budget expenditures and to reevaluate fiscal priorities in light of a potential economic downturn precipitated by the ongoing conflict.

The letter starkly cautioned the leaders of Israel about the severity of the economic downturn the nation is facing: "You do not understand the magnitude of the economic crisis that Israel's economy is facing ... Continuation of the current conduct harms Israel's economy, undermines citizens' trust in the public system, and undermines the State of Israel's ability to recover from the situation it finds itself in."

Among those signing the letter was Prof. Jacob Frenkel, former Bank of Israel head; Rony Hezkiyahu, former Bank of Israel banking overseer and national accountant general; along with former banking supervisor Yair Avidan; Haim Shani, one-time finance ministry executive; Prof. Eugene Kandel, past chair of the National Economic Council; former deputy governor of the Bank of Israel, Prof. Eytan Sheshinski; Tel Aviv University's Prof. Leo Leiderman; and 2021's Nobel Laureate in Economic Sciences, Prof. Joshua Angrist from MIT.

As the conflict with Hamas extends into its fourth week, the tech sector in Israel is encountering significant disruptions. According to a survey conducted by the Israel Innovation Authority and the Start-Up Nation Policy Institute, ~70% of tech enterprises and startups are experiencing operational challenges as many employees have been called up for reserve duty. The repercussions have rippled across the economy, prompting operational shutdowns ranging from construction firms to dining establishments and resulting in a wave of employee furloughs within the retail sector.

Recall that Israel mobilized a record ~360,000 reservists before its ground offensive on Gaza, draining ~8% of the workforce. Meanwhile, more than 120,000 Israelis have been displaced from their homes as the conflict escalates.

The reserve mobilization, combined with shutdowns of offices and construction sites, has triggered a sharp crash in business activity and disrupted everything from banking to agriculture, prompting comparisons to the economic impacts of COVID lockdowns.

At the start of the war, Israel ordered Chevron to stop production at the Tamar natural gas field to mitigate its vulnerability to attacks. The shutdown is estimated to cost Israel ~$200MM per month in lost revenue.

Bloomberg is reporting that (my emphasis):

• " The government is losing an equivalent of $2.5 billion a month , according to Mizrahi-Tefahot, a top Israeli lender.
• Private consumption fell by nearly a third in the days after the war broke out, relative to an average week in 2023, according to the Shva payments system clearinghouse.
• By one measure, the decline in credit card purchases was more dire than what Israel experienced at the height of the pandemic in 2020 , according to Tel Aviv-based Bank Leumi.
• Nearly half of the 500 high-tech companies surveyed last week reported a cancellation or delay of an investment agreement .
• The economic cost of the conflict will probably run to at least 27 billion shekels, according to Bank Hapoalim, or 1.5% of Israel's GDP. "

Markets have already begun reacting to these developments, with the local currency, the shekel, having reached 14-year lows, while the benchmark stock index is down ~10% YTD. Fitch Ratings , Moody's Investors Service and S&P all warned in recent days that an escalation of the conflict could result in a downgrade of Israel's sovereign debt rating.

Israel's central bank has cut its 2023 economic growth forecast to 2.3% from 3% (n.b., assuming the fighting is contained in the country's south). I believe it is highly likely that further downward GDP revisions are likely if the conflict does not significantly ease, as tourism, which represents ~3% of Israel's GDP , is at risk with airlines canceling most flights to Israel and tourists calling off trips.

2) Long-Run Economic Uncertainty

This section considers potential long-run implications for the Israeli economy, assuming the conflict remains contained, and is highly speculative.

Given the wide array of potential outcomes, I want to focus on what I see as a potential long-term demographic headwind. With Israelis' trust in the current government shaken, it appears that many citizens are increasingly open to emigrating to safer Western countries. Below, you can see that Google search queries for "green card" and "Canada Immigration" are at or near all-time highs in Tel Aviv and surrounding central regions. Current search interest for "green card" in Israel as a whole has not been this high since 2010; for "Canada immigration" it has not been this high since 2012.

While it would be somewhat naive to put much weight on this, it is not difficult to imagine the current crisis, along with prior political unrest regarding judicial reform, fuelling elevated net emigration.

3) Existentially Threatening War Risk

Finally, I address the least likely, though certainly credible, risk of the conflict escalating toward a broader regional or global conflict. The prospect of broader conflict has been enumerated extensively elsewhere, so I will not go in-depth here. However, I will note that the developments of the past weeks and days are consistent with further escalation. However unlikely a scenario of major escalation may be, I hope we can all see that it is a non-zero probability. In keeping with the cardinal rule of investing (i.e., do not lose money), the mere presence of a credible threat of a highly damaging armed conflict should be enough to sit this one out.

Below are some key facts/developments that I believe are consistent with the argument that Israel is on the path toward a broader conflict.

US Military Presence

The US military response seems to have evolved beyond the point of mere deterrence and is increasingly assuming defensive and offensive postures that signal genuine concern about escalation.

• 2 Carrier Strike Groups (USS Gerald Ford & Eisenhower ) positioned in the Mediterranean Sea
• USS Bataan and USS Carter Hall in the Red Sea carrying the 26th Marine Expeditionary Unit (n.b., ~2,000 Marines)
• Constant presence of aerial surveillance/anti-submarine warfare aircraft off the Israeli and Lebanese coastline (n.b., Boeing P-8 Poseidon, Boeing RC-135, Northrop Grumman RQ-4 Global Hawk)
• Deployed an additional ~1,200 troops to various locations in the region
• Deployed THAAD, Patriot, and Avenger missile defence batteries from the continental US
• ~27 attacks on various US installations across Iraq and Syria, with limited retaliatory strikes on bases in Syria

Yemen Joins the Fray

The Houthi rebel group has reportedly "declared war" with Israel. Due to the group's geographic distance and inferior military capabilities, this development is likely of little importance to the tactical situation. Still, it does signal other groups' willingness to be drawn into the conflict and will tie up Israeli naval and air defence assets in the southeast and the Red Sea.

Hezbollah Escalating

So far, Israel and Hezbollah have only had limited exchanges of fire on the northern border. However, in recent days, the attacks have increased in frequency and severity . Hezbollah's leader, Hassan Nasrallah, is scheduled to give a major speech on Friday, which many will be watching for signals about the group's intentions. This comes against the backdrop of Russia's Wagner group reportedly working with Syria to deliver surface-to-air missile systems to the Lebanese groups.

Conclusion

Considering the multitude of risks - from immediate economic disruptions due to the ongoing conflict, to potential long-term demographic shifts and the considerable chances of regional escalation - the current outlook for ISRA is fraught with uninvestable uncertainties. I recommend steering clear until the geopolitical situation normalizes.

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