Alpha Israel Fund – Political Update
We wanted to provide an update on the current political turmoil in Israel and explain how this affects the Pengana Alpha Israel Fund.
The first and most important factor is that Israel is still a thriving democracy and in fact, the only democracy in the region. That peaceful demonstrations and protests are happening across the country is a testimony to this.
The support for democracy and independent institutions across Israel provides solid grounds for confidence in the country and its economy over the long term. The present challenges can be expected to subside over time and Israel will continue to succeed.
So, what has happened?
Israel’s parliament ratified new legislation this week that rolls back some Supreme Court powers – which are a common feature of other democracies across the world.
The new legislation is an amendment that removes one, but not all, of the tools the Supreme Court has for over-ruling government and ministers’ decisions. Up until now, if the court deemed an executive decision “unreasonable”, it could be quashed. However, now once a bill becomes law, judges will no longer be able to do this, although they will still be able to rule against the government based on other legal grounds.
What has changed?
In the immediate term, probably very little. Some legal experts including advisers to the government have warned that it may leave it more vulnerable to corruption. This is because it makes it easier for the government as a whole or individual ministers to hire and fire officials for improper reasons. The government claims it has no such designs. The change, it says, will facilitate efficient governance and make it easier for democratically elected officials to pursue their policies.
It remains unclear what further judicial changes will be made. The government said on Thursday that it will seek to reach wider public agreement on further reforms during the Parliamentary summer recess, which takes place between August and mid-October. While this is a cause for some concern, as with its many other problems, Israel is expected to find a way to resolve the issue and move ahead stronger.
What are the implications of these developments to the Pengana Alpha Fund?
It is important to highlight that although it is a long-only fund, an ongoing strategy of downside protection from extreme market movement is in place. This currently protects the Fund’s domestic market exposure.
Some defensive positions were rolled over this week as some of the put options moved into the money, (i.e., the market price fell below the strike price). Accordingly, the Fund realised some of these gains by selling the existing contracts and establishing new positions a little further out of the money, i.e., at lower strike prices, to protect the Fund against further market falls.
Despite elevated levels of volatility, the broader market is up so far for the month, and the Fund is currently expected to deliver a strong positive return. (Putting the current political challenges into context, the Fund has returned approximately 5.0% in the month to 26 July and has delivered approximately 11.5% since the beginning of the calendar year). Elevated volatility levels should create welcome opportunities for active managers to take advantage of short-term distortions in the market.
How is the Fund positioned?
About 25% of the Fund is invested in companies that are either listed overseas or dual-listed. These companies are more sensitive to developments in these overseas markets, with a much weaker correlation to Israel’s market.
Israel’s economy is thriving, having been led by the technology sector over the past 15 years, a trend that is expected to continue. Israel has benefited greatly from rising revenues from the defense industry and gas exports which now form a big part of Israel’s tax base. This is expected to increase greatly in the coming years, even if there is a slowdown in the technology industry. The Israeli army continues to provide significant support to the sector.
Most of the companies in the Fund are key exporters, which have been helped by the recent depreciation in the currency. The potential effect of inflation and interest rates represents an economic challenge in Israel, as in most other major economies around the world.
However, the Fund holds mainly industrial and service companies that have net-cash positions and which are well-positioned to benefit from these trends.
FMS Enterprises produces military protective equipment, it has a market value of US$270 million, a cash surplus of US$85 million, is debt-free, and owns its real estate. The company earns around US$25 million per year and enjoys market growth within the defense sector.
Ilex Medical is a medical equipment supplier, it has a net cash position of approximately US$80 million, a US$250 million market value, and earnings of US$25 million per year.
Israel is a resilient nation with a strong economy that has experienced very challenging periods in its 75 years of existence. The country especially benefits from strong demographics and cutting-edge technologies – Nvidia and Intel’s research and development facilities in Israel continue to deliver innovative breakthroughs in chip design and artificial intelligence (AI).
Most of all, the amazing human resources in this small country will continue to push Israel to new frontiers. This remains a fantastic environment from which to deliver superior returns to long-term equity investors.
The Alpha team
