This ETF tracking Israel's hot cyberstocks is breaking out

  • Israel is expected to have strong GDP growth in 2018-19.
  • Israeli companies are underrepresented in global stock portfolios.
  • An ETF focused on Israeli tech stock, ITEQ, is up nearly 30 percent in one year.
Israeli Prime Minister Benjamin Netanyahu gives a press conference for the launch of 'Campus TLV' a technology hub for Israeli start-ups, entrepreneurs and developers at Google's new offices in Tel Aviv in 2012.
Jack Guez | Getty Images
Israeli Prime Minister Benjamin Netanyahu gives a press conference for the launch of 'Campus TLV' a technology hub for Israeli start-ups, entrepreneurs and developers at Google's new offices in Tel Aviv in 2012.

Israel's economy is racing. Analysts predict annual GDP growth for each of the next two years to be 3.5 percent. Israel, home to such global companies as cybersecurity firm Check Point Software and computing hardware business Mellanox Technologies, has its booming high-tech sector to thank.

A surging economy makes investing in Israeli companies a smart bet. But despite Israeli companies' impressive pedigree, they remain underrepresented in many of the portfolios of both American and Israeli investors, according to Steven Schoenfeld, founder and chief investment officer of New York-based BlueStar Global Investors LLC.

"If you look at tech broadly, Israel just doesn't appear on the radar, and investors haven't focused on it," Schoenfeld said.

There are 95 Israeli companies trading on the Nasdaq today, but the companies Schoenfeld is talking about are smaller, mid-cap names in Israeli tech that don't trade on overseas indexes. To bring broader exposure of Israel-based tech companies to both U.S. and Israeli investors, Schoenfeld's firm launched an ETF that focuses on Israel-based technology companies in 2015. It's named the BlueStar TA-BIGITech Israel Technology ETF (ITEQ), which tracks BlueStar's Israel Global Technology Index.

ITEQ chugged along in its first year of full operations, 2016, but with an annual return of under 4 percent, it attracted no more than $5 million. Yet over the last year, the ETF has grown. Up more than 27 percent last year, ITEQ now has $35 million in assets. That's still a blip on the landscape of an ETF industry that had inflows of $500 billion in 2017, but it does mark a seven-fold increase for ITEQ.

That same investment growth is expected for Israeli private and institutional investors as well. The Israel Securities Authority has picked BlueStar's Israel Global Technology Index to serve as the benchmark for four new high-tech funds expected to begin trading this year on the Tel Aviv Stock Exchange. These four funds, meant for private investors and institutional investors, such as Israeli pension funds, will invest in both publicly traded Israeli technology stocks and early stage private companies.

"The launch of these funds will change the way that both Israeli institutional investors and individual investors view and access Israeli technology investments," says Schoenfeld. "And at least $330 million will soon be allocating to Israeli technology stocks listed worldwide."

Whether investors have missed out on Israel-based investment opportunities is a matter of slight debate. Eran Nitzan, economic attaché at the Embassy of Israel in Washington, D.C., notes that the number of Israeli companies trading on the Nasdaq is third only to American and Chinese companies. "It's the strongest evidence why investors actually do focus on Israeli companies," said Nitzan. Still, he added, "Investing in Israeli companies does require some effort in collecting data and some willingness for risk."

While a Nasdaq-tracking ETF will give U.S. investors some exposure to Israeli tech stocks, the "exposure will still be quite low," said Neena Mishra, director of ETF research at Zacks Investment Research.

While large, mega-cap companies, like Check Point Software, are known to investors — the global cybersecurity company is in the Nasdaq 100 — smaller and mid-cap Israeli companies are not, Schoenfeld said. That's the argument for an ITEQ investment: for U.S. investors to put some of their money into under-the-radar smaller and mid-cap Israeli stocks, specifically. An investment in this ETF gives an investor entry to smaller-cap names, ones that will hopefully grow into global companies.

"That's what this portfolio is about. It's about innovation and not just tech companies," said Mitch Goldberg, president of investment advisor ClientFirst Strategy. "You're really buying small, innovative tech companies that you expect to become much bigger."

Israel's cybersecurity industry is second only to US

Israel has a track record of smaller companies becoming global enterprises, and there are several markers indicating its innovative tech sector will balloon further. The country's high-tech sector employs more than 200,000 people and represents some 10 percent of the country's overall GDP.

Israel's cybersecurity industry is second only to the United States in terms of investment dollars: Last year alone, Israeli cybersecurity companies big and small raised a combined $847 million, according to YL Ventures, an investment firm with offices in Tel Aviv and Silicon Valley. Equity deals in Israel-based companies made another large jump from 2016 to 2017, according to data from CB Insights: 158 deals representing $1.6 billion were made last year, compared to 131 deals totaling $1 billion the year before.

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The Israeli economy overall has solid growth prospects, with a mix of domestic industries such as banking and construction and export-oriented growth. Foreign companies, like Intel, have research-and-development centers in the country, too.

"Israeli companies, especially in the tech space, compete around the world," Schoenfeld said.

But Israel doesn't own innovation. Cutting-edge companies out of India, Japan and South Korea, to name just a few, also make attractive cases for more specialty investments that don't focus on Israeli companies in particular.

"This is about as narrow a tracking ETF that I've ever seen," Goldberg said. "To buy this, you really have to believe there is something special coming out of Israel, as far as technology innovation goes," he said, adding that his preferred way to invest in tech companies is through individual stocks. "I can't see any other reason to own it."

And when it comes to Israel-based investors, another target market for the ITEQ, even the large companies can represent missed investment opportunities. That's primarily because leading Israeli technology companies aren't listed on the Tel Aviv Stock Exchange, but rather abroad, on the Nasdaq or the New York Stock Exchange, or in London, Singapore, Australia and, increasingly, Hong Kong.

"The Israeli stock exchange has never been a huge end market for Israeli companies to go to do their IPOs or anything like that," said Tal Slobodkin, a partner at StageOne Ventures in Tel Aviv. "Most Israeli companies have always gone to the Nasdaq or the London stock exchange."

For U.S. investors interested in tech — that's a reason for them to invest in a Nasdaq-tracking ETF. Six of the top 10 fund holdings in the ITEQ are currently traded on the Nasdaq.

Where an ETF like the ITEQ could work is for the American investor with an aggressive tolerance interested in gaining diverse exposure to Israeli tech stocks that aren't just listed on major global indexes.

"If you want exposure to Israeli tech companies and you believe they have high growth potential, then an ETF like this makes sense," Mishra said.

By Andrew Zaleski, special to CNBC.com

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