Last month, "Globes" revealed that investment house Altshuler Shaham planned to reduce its customers’ exposure to Israeli stocks from 20% of the share portfolio to just 10%. The move by the largest investment house in Israel in provident funds resounded in the capital market, and many of the firm’s competitors, although they recognize the need to invest abroad, argued that this investment mix went too far.
It turns out, however, that the total exposure to overseas assets of the financial institutions that manage the public’s savings continues to rise, amounting to 42% of their investments at the end of March. That represents a 3% rise in overseas exposure since the start of the war in the Gaza Strip in October last year. Investments in foreign assets by Israeli financial institutions currently total nearly $300 billion.
Of course, taking money out of Israel and investing it overseas is not a new phenomenon. Some NIS 60 billion annually is deposited in the new pension funds alone, and, taking that together with savings products, the Israeli market has become too small for the institutions. The Tel Aviv Stock Exchange is characterized by low liquidity, with a relatively small number of shares available for trading. Moreover, since the beginning of last year, it has underperformed in comparison with overseas stock exchanges, because of the political and social turmoil and the security situation in Israel in the past couple of years.
Meitav Dash chief economist Alex Zabezhinsky points out that, since the government began to advance its judicial overhaul program, the exposure of Israeli financial institutions to the local market has fallen by some $10 billion, while total exposure to foreign assets (including through derivatives) has risen by $67 billion.
The trend is particularly marked among institutions managing provident funds and advanced training funds (essentially a tax-free savings program), whose overseas exposure has risen to 51.9% from 47.7% before the war and 41% at the end of 2022. For the pension funds, which still benefit from special bonds issued for them by the government, their overseas exposure was just under 45%, which compares with 38.7% at the end of 2022. For the old pension funds, the exposure is much lower and the change is minimal, from 16.1% in December 2022 to 16.7% last March.
The preference, or the necessity, as they call it, of the financial institutions for investment overseas also leads to higher exposure on their part to foreign currency. According to Bank of Israel data, the net exposure of the financial institutions to foreign currencies has risen to a peak of 21.7%, or $154 billion. A decade ago, in March 2014, the exposure was just 12.3%, and in 2002 it was less than 2.5%.
The gaps between the rate of exposure to foreign currencies and the institutions’ total holdings of foreign assets arise from the fact that a substantial part of the investment overseas is through contracts, or is denominated in shekels. On the other hand, the overseas exposure also includes dollar-denominated Israel government bonds.
Meitav’s Zabezhinsky explains: "In general, the institutions don’t want too high an exposure to foreign currency, because, in the end, they pay out pensions or advanced training fund savings in shekels. When they venture away from the local capital market and buy assets overseas, they have two ways of avoiding higher foreign exchange exposure. The first is to carry out currency hedging, which is costly, and the second is to buy assets, mainly stocks, by means of contracts, such as on the S&P 500. They then have no foreign exchange exposure other than on the premium they pay, and that has been the main way they have operated recently."
Risks and advantages
The large foreign exchange exposure carries risks, since it can directly affect the return on savings products, as exchange rates fluctuate.
"Exchange rate fluctuations are a significant risk," says Zabezhinsky. "If, tomorrow, the Israeli government reaches a diplomatic settlement, a deal for the return of the hostages, elections, or an agreement with Saudi Arabia, for example, the shekel-dollar rate could fall to NIS 3.3. If the exchange rate exposure ranges between 25% and 30%, appreciation of the shekel by 5% would cause large losses to savers. The financial institutions therefore raise their exposure, but don’t go too far with it, because everyone is waiting for the geopolitical event to end."
On the other hand, explains Yuval Beer Even, portfolio manager at Migdal Group, exchange rate exposure allows for diversification of currency risk. "A large exposure represents partial protection against falls in the markets and in Israel. It’s important to remember that currency hedging costs 1.5-2% annually, so that when currency exposure is higher, hedging costs for the investment track fall."
In fact, currency hedging has been a main factor affecting the shekel-US dollar exchange rate over the years, and this is what creates the connection between the rise in stock indices in the US and the value of the shekel. "In principle, exposure to foreign currency strengthens the shekel, even though we saw this link become disconnected at the start of the judicial overhaul legislation. When the market rises, for example the S&P 500 rises, the currency exposure of the financial institution rises, and in order to prevent that it sells dollars. And so when the market rose, the shekel strengthened, and when it fell, the shekel weakened. But since the beginning of 2023, that link has been disrupted, because everyone wanted to buy foreign currency, and so even when the US stock market rose, the shekel weakened."
So what influences the shekel-dollar rate today? Zabezhinsky: "The news. All the classic factors of the economy, interest rates, the stock market, or an investment surplus, are having a marginal effect, and what moves the exchange rate now is an agreement or no agreement, a deal or no deal."
Beer Even: "Shekel exchange rates are affected by many factors. There is no doubt that material changes in the exposure of the financial institutions have an impact, but the market is sufficiently sophisticated and has many players. At the same time, it should be pointed out that in the past year dollar-shekel trading has been thin, and so deals that in the past would have been swallowed up in trading now have a greater impact."
Published by Globes, Israel business news - en.globes.co.il - on May 27, 2024.
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