Until three years ago, the S&P 500 Index, which comprises the largest companies in the US, was the province of expert investors in Israel. Barely 1% of the total amount of money invested for the long term was channeled to the US index, NIS 6 billion in total. A great deal has changed since then.
It began with technology workers and young people with a high degree of financial awareness who diverted their investments and savings to the S&P 500, and it became a national phenomenon. An examination by "Globes" reveals that, within three years, the NIS 6 billion has become NIS 134 billion of the money in pension funds, provident funds and advanced training funds; no less than 8% of the Israeli public’s long-term financial assets.
One of the index’s best years
The judicial overhaul and the storm it raised in 2023, and the war in which Israel has been embroiled for over a year, boosted the trend. In fact, Israeli investment in the S&P 500 has more than doubled since the outbreak of war, about half of this arising from net new investment and the rest from the phenomenal return on the index this year. 2024 is shaping up as one of the US index’s best years ever. It has reached a new all-time peak 43 times this year, and yielded a return of over 22%. According to The Daily Shot website, between January and October this year the index has risen faster than in the corresponding period in any of the past 24 years.
According to analysis by Index Research and Development, NIS 75 billion net were invested in the Israeli pensions market in the past year (deposits less withdrawals, including transfers between funds). Of this sum, over half - NIS 41 billion - flowed to S&P 500 Index tracking funds. Only 37% went to active savings tracks managed by portfolio managers in Israeli financial institutions.
A glance at the returns yielded by the S&P 500 tracks in provident and pension funds makes the rush to these tracks entirely comprehensible. So far this year, the return is 24.6%, much higher than on any other track. In second place, by a long way, is the equities track, with a return of 16.5%.
Measured from the beginning of 2023, the gap is even wider. Investment in the S&P 500 has yielded a return of more than 50%, while the Tel Aviv 35 Index has given a return of under 20% in the same period.
The S&P 500 can be beaten, but it’s hard
The local stock market is not necessarily the problem. Investors all over the world are flocking to the S&P 500, with good reason. Warren Buffett, the biggest private investor in the world, is known as an enthusiast for it. Time after time, he writes to his investors about its advantages, saying that, for amateur investors, regular investment in an S&P 500 tracking fund will outperform most professional investors.
S&P Dow Jones Indices, which produces the S&P 500 Index, publishes data twice a year on investment funds that have beaten the index and those that have underperformed it. The figures, which are consistent with previous studies by other bodies, are unambiguous. So far this year, 43% of US investment funds have beaten the S&P 500 Index, but over the past five years that proportion falls to 23%, and over the past ten years, only 15% of investment funds have beaten the index.
Analysis by "Globes" of the accumulations in the various savings tracks shows that the increase in the amount of money channeled to the S&P 500 is mainly in the pension funds, which manage a total of NIS 869 billion. About 9% of those pension assets are directly invested in tracking the index, which compares with just 0.5% in August 2021.
On the eve of the war, in September last year, pension fund assets invested in tracking the S&P 500 amounted to 4% of the total, or NIS 28 billion. Within a year, the amount has almost tripled, to NIS 76 billion.
In advanced training funds, an investment channel that (for the time being) benefits from an exemption from capital gains tax for medium-term savers, about 8% of the savings (NIS 31 billion) are currently in S&P 500 tracking funds. In the provident funds, the total amount invested in the index has more than doubled within a year, to NIS 27 billion (7% of total assets).
War versus dream returns
"This trend is one that has had the best following wind there could be," says Yaniv Pagot, executive vice president and head of trading, indexes and derivatives at the Tel Aviv Stock Exchange. "In mid-2023, AI burst into our lives, giving an unexpected boost to technology sector stocks, which caused a jump in the whole S&P 500 index." Indeed, the shares of the Magnificent Seven (Apple, Microsoft, Google, Amazon, Nvidia, Meta, and Tesla) are responsible for 55% of the total return on the S&P 500 this year.
"At the same time," adds Pagot, "our troubles began: the advancement of the judicial overhaul and then the war. All this created optimal conditions for investment in the S&P 500 tracks, and that is obvious from the accumulation of assets managed on those tracks and in the returns they have generated for two years."
What haven’t portfolio managers understood?
Not everyone likes the rush to the US index. Some warn of the risks to Israeli savings when such a large proportion of them is invested in one product. Others are concerned about the impact on the Israeli economy and the local stock market, whose sources of capital are liable to dry up. And there are those whose concern arises mainly from their personal interest: management fees for index tracking funds are much lower than those for active funds.
"I think that actually the general savings tracks, which, in case we have forgotten, also invest every fourth shekel in US stocks, are more suitable to the vast majority of the population," says Pagot.
"At the professional level, is this track appropriate for everyone who has chosen it? For some of them, it’s very appropriate, but for a large proportion is really isn’t," says Yaron Dayagi of Index Research. "Those for whom it isn’t appropriate will generally come to understand that when it’s already too late."
What should investors switching their money to an S&P 500 tracks ask themselves?
Dayagi: "For long-term savings. I would ask myself whether the best thing is to invest my pension 100% in US stocks denominated in dollars. How is it that, up to now, not a single active track out of all the investment houses and insurance companies has behaved that way? As soon as I choose to invest my pension in a way that is fully linked to the index, I am in effect saying that of all the investment managers in Israel that have ever been, not one of them has understood that the solution for pensions is 100% linkage to stocks and the dollar."
It should be pointed out that it is possible to invest in S&P 500 tracking funds that are exchange-rate neutral. In addition, although the stocks in the index are of companies registered in the US, many of those companies are giants with extensive international business, with offices, sales, workers and revenue spread around the world.
A source from one of the financial institutions seconds Dayagi’s view, and says that diversifying the long-term savings portfolio is the right way. "In my opinion, it’s not correct to link everything to the S&P 500, to put all the eggs in one basket. For a young client who is starting to save, it’s still right to put some of the pension money linked to this instrument, but in my view the wisest investment is also to be on tracks managed by portfolio managers who able to navigate according to what happens on the markets, and not to be linked to this or that index."
Nevertheless, the S&P 500 is probably the safest and most profitable stock index. It can fall by double digit percentages and cause alarm, but the average annual return on it in the past 40 years is 10%, and so far it has never disappointed long-term investors in its long history.
"This exodus is a curse for the economy"
The greater risk is to the Israeli economy than to the individual investor. "For us as an Israeli economy thirsty for investment in Israeli companies, in infrastructure in the country and in local enterprises, this exodus of savers’ money is a curse," the source says. "Ultimately we are in a period in which foreign investors are hardly investing here, and rightly from their point of view; they’re waiting for the situation in Israel to become clear.
"Savers’ investments are the anchor of the economy’s growth. If the average Israeli investor, or the average Israeli financial institution, sends their money abroad, then in football parlance it’s an own goal. If we won’t invest in ourselves, then in the end there will be less money to finance the investment we need. When you look at the profile of the growth forecasts for the economy, part of it stems from the expectation of a decline in investment at this time.
"The money for these investment has to come either from the government or from private investors. I think that the trend will continue until there’s a heavy sell-off in the S&P 500. I recall that 2022, not that long ago, was a terrible year (the US index fell by about 20%, H. S.). Sometime or other there will be another violent year."
Another senior source at a financial institution says, "The bottom line is that whoever switched to these tracks in the past two years gained handsomely, so it can’t be said that he made a mistake." The problem, he says, is more the character of the Israeli investor. "There are often trends that the public flocks after. Once it was an investment house that was considered a star, today it’s a rush to a stock index that’s considered a star. So just as once people ran to star investment houses that went on to present a decline in returns and caused a wave of disappointment, here too some people may have got into linking their savings to the S&P 500 too late, and if there’s a fall, they will take fright and exit with losses.
"People also don’t know how to quantify the risk in this situation, for example, the fact that the return on the index is largely dependent on a fairly narrow group of stocks. Another matter is the foreign currency risk. We in Israel are in an unusual period that is negatively affecting the shekel. But over the years, there has been a negative correlation between Wall Street indices and the shekel-dollar rate (when the indices rose, the rate fell, i.e., the shekel strengthened). When the day comes and sanity is restored, that negative correlation is likely to return. People are essentially buying two products here: the stock index, and a 100% dollar investment. On the day that Israel’s risk premium falls, they are liable to lose twice over: both a decline or stagnation in the index, and a fall in the shekel-dollar rate."
Another factor fueling the Israeli public’s rush to investments that tracks the S&P 500, according to this source, is distributors of financial products and insurance agents. "The easiest thing is for them to say to you, you were on a certain track, look at the phenomenal return this index has made, why not switch?"
A veteran capital market player believes that another factor has entered the equation: social media. "Many people make their investment decisions with the help of all kinds of Facebook and Telegram groups. There, it’s very easy to show the strong past performance of the index, and then to give all kinds of recommendations. I actually think that most agents and pensions consultants will give more balanced or traditional recommendations. But today there’s a very strong push from social networks."
The same player says that the regulator also bears some responsibility. "At the beginning of July this year, the reform in long-term savings came into force, and it basically leaves the S&P 500 as the sole purely overseas track to which it’s possible to be exposed. A far as other overseas tracks are concerned, investment managers have discretion. So an Israeli investor who wants to put his pension overseas is generally channeled to that US index. It’s a sort of regulatory failure."
Published by Globes, Israel business news - en.globes.co.il - on October 13, 2024.
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