Unfortunately, our comment last month that Israel was “Covid free” was premature.  The Delta Variant, brought across the Israeli border by unvaccinated children returning home, has led to a surge in cases and a new “soft suppression” strategy to hopefully avoid a further lockdown.  Israel has one of the highest vaccination rates in the world at around 70% of the mature population, and now intends to vaccinate children between the ages of 12 and 16 using the Pfizer vaccine, which was recently approved by the US FDA and Israeli authorities.

Top Holdings (alphabetically)

FMS Enterprises Migun

Israel

Aerospace & Defense

Fox Wizel Ltd

Israel

Apparel Retail

Nice Ltd

Israel

Application Software

Peninsula Group

Israel

Specialized Finance

Priortech Ltd

Israel

Electronic Components

Unfortunately, our comment last month that Israel was “Covid free” was premature. The Delta Variant, brought across the Israeli border by unvaccinated children returning home, has led to a surge in cases and a new “soft suppression” strategy to hopefully avoid a further lockdown. Israel has one of the highest vaccination rates in the world at around 70% of the mature population, and now intends to vaccinate children between the ages of 12 and 16 using the Pfizer vaccine, which was recently approved by the US FDA and Israeli authorities.

The last year has been characterised by volatile markets, driven initially by the onset of Covid in developed economies. A period of stabilisation followed and then a rapid recovery and appreciation in stock markets, which has continued into 2021.  A more in-depth examination of the market, however, shows that there has been significant internal variation between stocks of different types and sectors. This provides a potential opportunity for the Fund, as ultimately it is the lasting economic value of companies that determines their longer-term performance.

The difficulty lies in ascertaining the likely impact of the latest Covid outbreak. We are hopeful that the recent trends of rapid economic recovery and a return to economic growth, in parallel with a decline in morbidity and increased effectiveness of vaccines, will continue.  At the same time, though, we are concerned about the potential economic effects on some sectors, and we are monitoring these carefully. At the time of writing, it seems that our fears have been unfounded and the high vaccination rate is protecting the Israeli economy from some of the difficult events faced by other countries. We have therefore made no changes to date to the Fund in response to the recent Covid outbreaks.

The aim of the Pengana Alpha Israel Fund is to capture and benefit from Israel’s unique economic characteristics and its position as a global leader in the Technology sector. As a result, the Fund is heavily exposed to this sector, which has underperformed during the first half of 2021.  During this period, sector performance has diverged significantly: Oil & Gas +32%, Real Estate +28%, Banking +26%, Cleantech -12% and Technology +6% (compared to +38% in 2020).

This is to some extent a reflection of the differentiation between the performance of value and growth, that we have highlighted before. At the beginning of the year, we saw a return of investors to the battered “value” shares and to more traditional investment channels but, as we noted, this distinction can be somewhat misleading, and recently we have witnessed a significant return to “growth” companies. In the past six months, the Fund’s performance was mainly influenced by this rapid change in fortunes, the cost of the protection strategy in a rising market, and a sharp decline in companies with higher risk characteristics, which constitute about 20% of the Fund.

This higher risk allocation includes some of the Fund’s IPO investments. IPOs have continued to surge in 2021 and at the time of writing, over 60 companies had listed on the Israeli stock exchange so far. We are very selective and have invested in only a few of these opportunities, however, we seek to listen to every story so that we can assess future results.

There are two types of IPO.  The first are good companies, many of them well established with years of revenue and profitability. These companies should be examined according to parameters of quality, growth forecasts, and profitability. The second are companies that are newer, many of a more technological nature, and are in the early stages of revenue generation, with only a future-profitability model. As investors and non-speculators, we limit our exposure to these early-stage companies and only maintain small positions.  However, their decline in the last quarter weighed on the Fund’s return, despite the conservative allocations.

We strongly believe that the value/growth dynamic will balance out in the second half of the year. We witnessed this in the second half of June in the US market, with a flow to growth for the first time in 11 weeks and the most significant in six months. We will continue to carefully monitor developments with the Covid virus and the companies we hold in the Fund, and note that much of the recent share price volatility does not reflect the nature of the companies’ underlying business models, which in most cases have not changed.

Stock in focus

Massivit 3D Printing Technologies is a breakthrough technology company with a disruptive agenda and a good example of the short-term volatility we have described above. The Massivit 1800 Flagship 3D Printer is the first of its kind to produce super-size, crowd-stopping signage, displays, and props for visual communication. Offering unprecedented printing speed, it is designed to enable business growth through the scalability of printing heads and versatile printing materials. The Company has 2 globally renowned strategic investors – Yaskawa (Symbol: YEC, a Japanese company and the world’s largest manufacturer of AC drives and motion control products) and Stratasys (Symbol: SSYS, an American/Israeli company and global leader in 3D printing and additive solutions, materials and services).

Massivit is a 2.5% position in the Fund and fell 27% in June. There were no material reasons for this significant drop and, on the contrary, the Company released its initial forecast for Q2 at the end of June, which showed a significant improvement in revenues of 62%. As a result of this announcement, the stock price bounced back by 25% (as at the time of writing). This example illustrates the importance of a long-term view and not giving too much attention to short-term stock market fluctuations (both positive and negative). We maintain a significant degree of confidence in this position going forward.

Macro Developments

The recent composite state-of-the-economy index indicates that the recovery in economic activity is continuing, with a slight slowdown in the pace. Data from the Bank of Israel shows the composite state-of-the-economy index increased 0.24% in May, following sharper increases of 0.45% and 0.34% in April and March respectively. Since the start of the year, the composite index has declined by 0.2%.

The Bank of Israel is forecasting growth of 5.5% for the Israeli economy in 2021 and has increased its forecast to 6% in 2022. The forecast government deficit for 2021 was revised downward, against the backdrop of the recovery in the economy, such that the financing requirements of the government are expected to be lower than previous estimates. However, as discussed above, it is unclear as to the impact of the Delta Variant on economic activity for the remainder of the year.  While the impact thus far has been muted, it has the potential to materially impact the above forecasts and we are monitoring this carefully.