Commentary

Positive equity market momentum from the last quarter of 2020 continued into January. Vaccine-related progress in Israel and expected economic improvement, globally and domestically, combined to place the Israeli market in a strong position going into the new year.

There was a remarkable divergence between two segments of the Israeli market over 2020.  On the one hand, Israeli stocks with predominantly global sources of revenue outpaced the broader benchmark, whilst Israeli stocks with predominantly domestic sources of revenue underperformed. The divergence in P/E ratios across these segments is currently at a 5-year high, with domestically orientated stocks trading at a P/E ratio of 14x compared to 28x for globally orientated stocks.  Part of the justification for this is that globally orientated stocks demonstrate more growth potential, with the majority of them trading on the Nasdaq. However, an alternative explanation is that while Technology, Biotech, and green energy stocks fared quite well after the initial shock of the coronavirus, traditional value sectors like Financials, Energy, and Real Estate did not. Historically, following every period in which this divergence has occurred, there has been a strong recovery by the domestic orientated stocks.

This combination of relatively low P/E ratios and relative underperformance signals that the market may not have fully priced in an economic recovery in Israel in 2021 and beyond. At the same time, Israel is leading the world in vaccinations (currently over 3.2 million people) and expects its population to be fully vaccinated by the end of Q1 2021.

Last year proved once again, in dramatic fashion, that investors should not try to predict short-term market performance. The Fund benefitted from having multiple strategies within the same portfolio, specifically Growth as well as Value, which allowed us the flexibility to move within our universe of companies (both domestic and global) in a market that was characterized by high variability.

The Fund also benefitted from our out-of-the-money put option protection, a discipline we have adhered to over the life of the Fund. These options protect investors against catastrophic falls, which, as usual, may strike without warning

STOCKS IN FOCUS

Despite a rocky start, Israel experienced record capital market activity in 2020, with an unprecedented number of IPOs valued at more than $9 billion raised on public markets in Israel, the US and other worldwide exchanges.  This is an impressive increase from the $2.2 billion raised in 2019. The IPO pipeline for 2021 is arguably the strongest-ever, with more than 10 Israeli “unicorns” (privately owned businesses valued at more than $1bn) that have taken steps towards either an IPO or acquisition via a SPAC (special-purpose acquisition company).

Our increased exposure to Pre-IPO investments has also generated significant investment performance.

The increase in public listings of private companies is highly positive for the Fund, both as local investors in technology-oriented companies with long-term growth potential, as well as due to our large shareholding in Israel’s leading underwriter “Poalim IBI” (traded under the symbol PIU on the Israeli stock exchange). In the last quarter of 2020, we participated in several IPOs of this kind and will maintain our investments in those that we believe have long-term potential. Two such companies are GenCell and Human Xtensions, which, in our opinion, have the potential to increase in value significantly in the coming years.

GenCell is engaged in the field of alternative energy and provides power supply and storage solutions for remote stations via hydrogen fuel cell-based generators. The company’s main growth potential comes from its products that use ammonia-free hydrogen, which is a breakthrough in the fields of Energy and Technology.

Human Xtensions develops robots for non-invasive surgical procedures.  They allow the surgeon to perform complicated actions by imitating his hand movements and accurately transferring them remotely to the surgeon’s tools. These robots represent a significant upgrade on the current technology and can be used for a wide range of surgeries performed today via traditional methods.  The robots’ price is relatively low compared to the main alternative, the da Vinci Surgical System.  This costs about $2.5 million and requires a long training period compared to about $100,000 for the Human Xtensions’ device.

MACRO DEVELOPMENTS

• Moody’s maintained its investment-grade rating and stable outlook for Israeli government debt, expressing confidence in the country’s economy despite two coronavirus lockdowns and a “polarized political system.” The rating “reflects Israel’s robust growth potential, strong external position, and highly credible institutions” the Agency said. Moody’s cited Israel’s offshore natural gas reserves and tech sectors as positives but noted that the “polarized political system weighs on fiscal policy effectiveness”.
• S&P’s assessment assured investors that by mid-2021 Israel’s government will return to its longstanding policy of fiscal responsibility. In mid-December, an S&P Sovereign & Public Finance official cited Israel’s consistently positive Balance of Payments surplus of 3-4%, which gives Israel “…the largest surplus in the world among countries that do not export raw materials.”
• Finally, in mid-January, Fitch affirmed Israel’s A+ credit rating and its stable outlook, predicting 5.4% GDP growth for 2021 and 4.1% growth for 2022. Like its above-mentioned counterparts, Fitch sees economic restrictions easing by H2 of 2021, and believes that Israel’s budget deficit is expected to moderate to approximately 9% by H2 2021 from 11.7% at the end of 2020. Like S&P, Fitch emphasized Israel’s current account surplus, which grew to 4% of GDP in 2020.
• Israel’s Debt to GDP ratio as of the end of 2020 stood at 73%, a major increase from the 60% levels before COVID-19 but is still much better than most developed & emerging economies. Fitch and other analysts believe that this ratio could peak at 80% later this year, especially as a massive economic relief spending program is being implemented with grants being made available for companies, new businesses, and households.
• Israel’s world-leading COVID-19 vaccination drive is demonstrating the country’s public health prowess and is expected to have significant long-term economic benefits as Israel emerges from the pandemic.
• Israel will have another national parliamentary election on March 23^rd, which has created renewed uncertainty.
• The geopolitical environment for Israel continues to improve, with further normalization of relations with the Arab and Muslim world.