A positive outlook for Israel

The Fund rose 1.2% (Class A) and 1.1% (Class B) in March, underperforming the Tel Aviv Stock Exchange 125 Index, which rose 2.1%.

Pleasingly, the Fund had a strong quarter with a positive return of +3.8% in the AUD class, comfortably outperforming the Index. The March quarter presented a number of challenges for global markets, with the S&P 500 and NASDAQ falling by -4.9% and -9.1% respectively. If not for a significant bounce in the second half of March, the performance would have been a lot worse. Against this backdrop, the Israeli market performed particularly well with a first-quarter return of +1.9%.

Top Holdings (alphabetically)

Alony Hetz Properties

Israel

Real Estate Operating Companies

Bank Hapoalim BM

Israel

Diversified Banks

Kenon Holdings Ltd

Singapore

Independent Power Producers & Energy Traders

Medi Power

Israel

Diversified Real Estate Activities

Telsys

Israel

Technology Distributors

During the month, we implemented a change in the Fund’s downside protection put option strategy. Significant fluctuations in the market led us to use an out of the money put spread with a shorter date range instead of naked put options. For the most part, the Fund holds a downside protection strategy in the form of far from the money put options, and dynamically adjusts the put portfolio to reflect the markets most relevant to the Fund’s structure and exposure. Recently, mainly due to market declines, we have made certain adjustments as some of these options have moved to a declining margin (closer, shorter protection but on the other hand more limited protection and cheaper). In 2021 this protection strategy was costly however the Fund benefitted from the proceeds in the first quarter of 2022.

The main detractors this month were Massivit 3D printing (Sector/Industry -Technology/Computer Hardware), which was down by -20%, and InMode (Sector/Industry: Healthcare /Medical Devices), which was down -14%.

Other notable  stock developments included:

• FMS (Ticker: FMS) and Rada (Ticker: RADA) continued to perform well as the Russia-Ukraine conflict continued. FMSis particularly well positioned as one of the leading suppliers of protective ballistic protection raw materials. It was the first company in the world to produce commercial UD-PE and UD-Aramid fabrics and the first to produce pressed UD-PE panels. The company is a world leader and pioneer in advanced ballistic protection technology and manufacturing, and one of the main sources worldwide for ballistic protection raw materials and products of bulletproof and anti-stab vests.  FMS has strong global distribution, supported by significant current demand for its products, however, we are mindful that the company faces challenges recruiting workers (due global labour shortages) and sourcing of raw materials. However, first quarter results were good and appear likely to continue to significantly improve over the remainder of the year. The company also distributed a very large dividend (funded from its large cash surplus).
• A large increase in global demand for semiconductor stocks led us a few months ago to slightly reduce our holdings in Priortech(Ticker: PRTC) and Camtek (Ticker: CAMT). After a 25% reduction in Camtek’s share price, we once again increased our position back to 4% as we believe that it’s long-term outlook is very positive, despite a potential short-term decline in demand.
• We continued to increase our holding in Checkpoint Software Technologies (Ticker: CHKP), which now accounts for 4% of the portfolio, as we believe it is a quality company in an industry with strong tailwinds, which was overly punished by the market for weak growth and neglect of the growing cloud market. However, there are signs of change in recent reports, and the company has an asset in the form of a quality client base that we believe will be happy to use the company’s services if it is able to provide quality solutions to the cloud as well. We will monitor the company’s business progress later this year and manage the position accordingly. At current pricing, we believe that the upside potential outweighs the risk.

As usual, there was no shortage of short-term factors affecting market performance: the Russia/Ukraine war, supply chain problems, and more. We believe (as referenced in our end of year report) that the most significant factor in the coming year will be the expected change in the role of various central banks around the world. Unprecedented liquidity injections since the beginning of COVID, along with zero interest rates, have given way to reducing balance sheets and raising interest rates, impacting the ability of central banks to steer markets to a soft landing over the short and medium-term. The war in Ukraine makes this task even more complex, since it generates inflationary pressures in an already heated market. Whilst these shorter-term factors are important to consider, we note that as always, we continue to believe that in the long run, investing in both quality companies at fair prices, and lesser quality companies at excellent prices, is likely to generate satisfactory returns in any macro environment.

Overall, the Israeli economy is performing well:

• Whilst inflation is rising, it is still far from the high rates seen in other parts of the world;
• The government enjoys a revenue surplus and a strong balance sheet in global terms;
• High-tech companies still attract significant global investments; and
• Local gas reserves are a significant anchor for the economy. The ability to restrain the increase in energy prices will become a much more substantial asset in the coming years.

Stock in focus

In this month’s report, we look at our position in one of the biggest beneficiaries of Israel’s natural gas reservoirs. Ratio Energies (symbol RETI) delivered its first gas to the Israeli domestic market in December 2019, with the first exports (to Egypt and Jordan) following in January 2020. Ratio has a 15% holding in the Leviathan gas field, which holds 33 TCFG (trillion cubic feet of gas) in place and 22 TCFG recoverable.  Leviathan was one of the largest gas discoveries of the last decade and will more than double the quantity of natural gas flowing to the Israeli economy today.

There are a number of factors that we believe will generate value in Ratio:

• The recovery of energy prices worldwide, which are mainly driven by the rapid pace of global economic recovery, raising attractiveness to the implementation of various development options for the reservoir, and commercialization of significant additional quantities of gas from the Leviathan reservoir from Israel to its neighbours – and perhaps even to European countries.
• We estimate that in the coming year the various partners holding the repository will reach a decision regarding the continued development of the reservoir, which is expected to inject value in the short term. In our opinion, the likelihood of a move to expand the production capacity is high, based on the entry of Chevron into the partnership. Chevron is a significant and active global player that replaced Noble Energy’s 40% holding in the reservoir, and also functioned as the operator of the reservoir.
• We see continued growth at solid rates of demand for gas in the domestic economy due to the reform of the electricity sector that supports the transition from coal-fired power plants to cleaner stations to transport natural gas. Ratio, whose balance sheet was quite leveraged, is starting to generate strong flows that will significantly lower leverage levels in the coming years.  The significant flows that are expected for the company as early as this year, and in the coming years, should enable it to refinance the debt and deploy it more efficiently. This would increase the net flow to shareholders in the coming years, which will also allow the distribution of a dividend.   Ratio currently trades at a market cap of $720 million USD, with net debt of approximately $700 million. The expected cash flow in the coming years is expected to be nearly $200 million per year, which will allow the company to easily service the debt and reduce net debt very quickly.

Macro developments

Israel’s exports in 2021 peaked at $143 billion USD – a 25% jump compared to 2020 when exports stood at $114 billion USD. The Ministry of Economy predicted that exports would be $120 billion this year – and then raised the forecast to $135 billion, with the actual result significantly higher. The significant increase is explained by the export of high-tech products, that are increasingly taking up a significant share of Israel’s exports. Software exports (which are a significant component of the exports of high-tech companies) grew by 26%, and today constitute the leading export industry with a 27% share of all exports.

Exports derived from the sale of start-ups grew by 273% and returned to their pre-COVID levels. This is a particularly high figure compared to developed countries and a testament to the evolution that the Israeli economy is currently undergoing.

Israel’s Credit Rating – Moody’s upgrades Israel’s outlook to positive, affirms A1 rating

On April 8, the global rating agency Moody’s upgraded Israel’s outlook from “stable” to “positive” and affirmed its sovereign credit rating at “A1”. Moody’s indicated that the key drivers for the change in outlook included the government’s reform agenda that aimed to address longer-term challenges, as well as the agency’s expectation of a further reduction in the government’s debt ratio, and the strength of its tech exports. Israel’s economy grew 8.2% in 2021.

Moody’s statement pointed out that the performance of the Israeli economy beat forecasts thanks to high tax revenues. This is reflected in the reduction of the government deficit by 7% of GDP within one year – one of the strongest performances among the OECD. Moody’s expects the deficit to be 3.4% at the end of 2022, lower than the original target of 3.9%. It is noted that the debt-to-GDP ratio began to decline last year, and the company expects it to reach a rate of 64% by 2024. The company’s statement also said that the approval of the credit rating reflects a balance between a stable economy with good growth data and a high public debt burden. Moody’s also noted that the Government’s proactive policies and growth figures during the COVID pandemic were better than most OECD countries, with a negative growth rate in 2020 of only 2.2% and a high growth rate of 8.2% in 2021.