Israel Hedge Fund Association Conference, Tel Aviv: A Summary
A trip by COOConnect to Tel Aviv to attend the Israel Hedge Fund Association (IHFA) Conference found an industry with enormous potential but a number of challenges are likely to stymie its emergence anytime soon. Here are some of the key issues facing the Israeli hedge fund industry.
Israeli hedge funds have grown their assets by 33% to $2.66 billion over the past two years amid strong performance and an emergence of new talent, according to the 2014 Israel Hedge Fund Survey by Tzur Management, a Tel Aviv-based administrator. The average hedge fund in Israel controls approximately $30 million in Assets under Management (AuM) although the median AuM is just $10 million. The number of Israeli-based hedge funds also increased by 50% since 2011 and presently stands at 89. The survey highlighted there were 30 new launches in 2013 with an average launch size of $11 million, a figure higher than in previous years. This growth comes amid solid performance among Israeli managers. The Tzur Capital Management Index of Israeli hedge fund performance (TCMI) showed the average manager in Israel posted gains of 17% in 2013, whereas the HFRX Global Hedge Fund Index gained 6.7%. Forty-two per-cent of hedge funds employ quantitative strategies. This should not come as a surprise given Israel’s strong reputation in information technology, research and development, and biosciences. This is followed by long/short equity (30%) and event driven (13%). The perception that Israeli funds are focused primarily on local markets is wrong – 60% of firms surveyed by Tzur Management, said they had no exposure to Israeli markets. Many hedge funds at the IHFA conference said the Israeli market was too small and not liquid enough for their strategies to succeed.
Given the country’s size, Israel boasts a sizeable investor community with approximately $300 billion in investable assets. The majority of the country’s investors are high-net-worth-individuals. Institutions such as pension funds and endowments are more comfortable investing either abroad, or in domestic private equity, real estate or venture capital firms. Many have negative perceptions of hedge funds. In 2000, restrictions on domestic investors allocating money abroad into foreign institutions were lifted. In 2006-2007, a few institutions started to invest in foreign hedge funds only to be burnt in 2008. The Bernard Madoff fraud also tainted investor opinions of hedge funds with many associating – unfairly – the hedge fund industry with Madoff. While the Madoff fraud affected a number of institutions, his actions had a particularly devastating impact on the Jewish community. A number of victims of the fraud were Jewish educational institutions and charities including the Yeshiva University, Hadassah, the Jewish Community Centers Association of North America and the Elie Wiesel Foundation for Humanity. The Chais Family Foundation, a charity that worked on educational projects within Israel, was forced to shutter because of its exposure to Madoff. Educating Israeli investors must be a priority for managers if they are to secure meaningful capital and burnish the negative perceptions of hedge funds endemic within the country. Israeli investors are also behind the curve of North American and European allocators when it comes down to conducting operational due diligence on hedge funds. The lack of size and scale, and indeed institutional standard operational infrastructure at Israeli hedge funds, is a put off for foreign investors. Many Israeli hedge funds concede that being based in Tel Aviv is a disadvantage as operational due diligence and investment due diligence teams are reluctant to make the journey to conduct on-site visits. If an Israeli manager wants to attract foreign capital, they must have a presence in the countries where they are soliciting investors, or appoint a third party marketer. Given the lack of scale at the majority of the country’s hedge funds, having a foreign presence would be too cost prohibitive. Those few managers that are chasing foreign capital are focusing on the US, which the country has historical ties with. The Alternative Investment Fund Managers Directive (AIFMD) is discouraging Israeli investors from pursuing European money although the majority have little or no awareness of the rules.
Regulatory stumbling blocks
Israeli tax law is – quite frankly – a disaster zone. It is extraordinarily muddled to the extent multiple service providers give wholly different interpretations of how it is enforced. It is probably the single biggest hindrance to the emergence of a successful domestic hedge fund market. Eighty per-cent of fund managers surveyed by Tzur Management concurred Israeli tax law was their biggest stumbling block to growing their businesses. At present, Israeli investors are subject to a capital gains tax of 30% if they allocate into hedge funds instead of the standard 25% if they invest in all other types of investment vehicles. This is irrespective as to whether the fund is domiciled within Israel or in an offshore jurisdiction. Israeli tax authorities do not care where the fund is domiciled but where the manager is located. Furthermore, domestic investors are taxed at the end of each calendar year even if there have been no realised gains. The lack of safe-harbour rules also dis-incentivises foreign investors from putting money to work in Israeli hedge funds. Industry associations and service providers are lobbying the government for change. There is mixed opinion as to whether change will materialise. One hedge fund manager advised the Israeli tax authorities offer a tax exemption for foreign hedge funds for a 10 to 15 year period in order to attract talent. That same manager explained there was a dearth of available talent, which again made it difficult for the industry to fully institutionalise. Asked how likely a tax exemption would be, he retorted within the next 200 years, adding he was an optimist. Israeli hedge funds are not regulated by the Israel Securities Authority (ISA) at all. This lack of oversight is an issue for foreign institutions although it is not a problem for the domestic allocators. Opinion is divided as to whether regulation is necessary. Opponents point out the industry is tiny and regulation could lead to additional costs. Others highlight the lack of regulatory oversight means the industry lacks structure, and warn there is a higher potential for fraud. The Israeli regulator has a history of replicating Anglo-Saxon regulation although one provider says it typically adopts the worst aspects of US and UK rules.
The Israeli industry is very small but has potential to grow exponentially. Nonetheless, this is conditional on the country’s tax authorities and regulators changing its current stance towards hedge funds, and reforming its tax system.