Israeli hedge fund industry continues to grow
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 controlled approximately $30 million in Assets under Management (AuM) although the median AuM was 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%.
“We are seeing a number of new managers enter the fray. Many of these managers have previously worked at mutual funds or pension funds and are launching Israeli-focused hedge funds. We are also noting a growth in quantitative hedge funds, which are being launched by individuals with experience in research and development, army technology, high-tech industries, biosciences and academia. Quantitative strategies represent the bulk of the Israeli industry with 42% of managers employing this strategy. The third growth area is where managers who have worked in big financial centres like New York or London are returning to Israel for personal reasons. These individuals are likely to launch global-focused or macro or currency trading hedge funds,” said Yitz Raab, managing partner at Tzur Management.
Nonetheless, despite this growth, the Israeli industry remains small and attracting meaningful capital from institutional investors is a challenge for the country’s hedge funds. Forty-five per-cent of capital controlled by Israeli hedge funds is derived from institutions compared with 55% from private investors, said the survey. The majority of this money is allocated by Israeli high net worth individuals with foreign investors accounting for just 20% of capital invested in funds managing in excess of $30 million.
The biggest hindrance for managers to gathering assets is Israeli tax law with 80% of respondents to the Tzur Management survey stating it was one of their biggest stumbling blocks. One lawyer, speaking at the Israel Hedge Fund Association (IHFA) Conference in Tel Aviv, said the 80% figure surprised him, adding it should be closer to 100%. 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 investment vehicles. This is irrespective as to whether the manager is domiciled within Israel or in an offshore jurisdiction such as the Cayman Islands. 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. “It is actually easier – speaking from a tax perspective - for an Israeli investor to allocate to a non-Israeli hedge fund. We are working with the relevant regulatory bodies to rectify this situation although whether this happens remains to be seen,” said Raab.
Israeli institutional investors also have mixed experiences of hedge funds. “Until 2000, Israeli institutions were barred from allocating capital abroad. In 2006 and 2007, they started investing in hedge funds and some got burnt in 2008. However, I am confident the negative mind-set prevalent among our domestic investors will change over time. The Israeli investor community controls roughly $300 billion and if they just allocate one per-cent of their portfolios into domestic hedge funds, we would see a doubling in size of the Israeli hedge fund industry. I would love to see Israeli institutions investing five or seven per-cent of their capital into hedge funds like they do in the US, and I hope this will happen in time,” said Raab.
Another stumbling block to attracting foreign capital lies with the lack of scale inherent at the overwhelming majority of Israeli hedge funds. “Foreign institutional investors are reluctant to invest in sub $1 billion hedge funds. The biggest managers in Israel run approximately $300 million. Large institutions – both foreign and domestic - like pension funds cannot invest in our domestic managers because they tend to write big tickets and cannot be seen to own the fund, while they are also subject to strict risk criteria. Many simply are not going to devote the resources to conduct on-site operational due diligence for such small managers. However, I am increasingly fielding calls with investors inquiring about Israeli hedge funds,” commented Raab.
The bulk of hedge funds are not regulated by the Israel Securities Authority (ISA) and this lack of regulatory oversight is an issue for some institutional investors. “Israeli managers are not subject to comparable levels of regulatory oversight like in the US and EU. We do get some foreign institutional investors expressing concern about the lack of regulation although it tends not to be a cause for concern among the domestic investors. However, I believe our industry is too small to be regulated although as it grows, this might change,” said Raab.
One problem facing Israeli-focused hedge funds is the scarcity of prime brokers operating within Israel. There is no official prime brokerage industry per say although large-scale domestic banks can offer execution, securities lending, margin and reporting to clients trading Israeli securities. “If a manager trades Israeli securities, they sometimes have to have several accounts with different banks as a single bank may not offer a one-size fits all service. It is probably a cheaper rate to go with multiple Israeli banks than appoint an international prime broker. However, I do believe a mini-prime brokerage market will emerge in Israel, mainly because the bulge bracket primes do not view Israel as a commercially viable market as the managers are too small. Investors also recognise Israeli banks weathered the financial crisis. While our domestic banks have small balance sheets relative to the international firms, investors do not view Israel’s banks as a counterparty risk,” said Raab.