Migdal Insurance is the largest investment manager in Israel. It manages more than $100 billion, but where is all this money actually invested? Among the diverse portfolios under its management, which include directors and officers (D&O) liability insurance, pension funds, professional development funds (“keren hishtalmut”) and mutual funds, is a portfolio called “Fund Y” (“keren ‘yud’”). This fund includes the insurance for Migdal’s own directors and officers, in a plan called “sharing the profits,” in which the company shares members’ profits, skimming 15 percent off their returns. This is the largest portfolio Midgal manages and one of the largest in Israel. According to the company’s asset distribution report for the end of September 2021, the value of the assets in this portfolio totaled 75 billion shekels ($23.8 billion).
If we were to survey the members of Fund Y and ask them about the fund’s financial makeup, they would undoubtedly say that this was a solid portfolio, most of it invested in safe Israeli securities and bonds, and that it was much safer than investing in the stock market. This would be a mistake. According to the company’s report regarding the distribution of its investments and its stock composition, half of the money allocated to D&O insurance at Migdal is invested not in Israel but overseas, and not in solid investments but in stocks considered risky, such as shares, ETNs that track stock indexes, funds that invest in tradable and non-tradable securities, and in real estate.
More specifically: At the end of September, Migdal’s Fund Y held 25 percent of its assets in stocks, 11 percent in investment funds, 8 percent in real estate, 9 percent in ETFs and 5 percent in mutual funds. All of these are assets essentially linked to stocks; an interim summary indicates that half the portfolio is directly stock-linked. If we add to this the fact that some corporate bonds (15 percent) are often more like stocks than bonds – and even if we take into account the fact that only 92 percent of the portfolio is invested in securities, since more than 8 percent of it is held in banks as cash – it turns out that 60-70 percent of the fund is invested in stocks. This is a very high degree of risk for a fund that is meant to finance pensions, and is quite different than what most of the public imagines.
And in which country are all these stocks or quasi-stocks invested? Until recently, securities portfolios managed in Israel had what is known in the world of finances as a “home bias,” namely, a preference for investing in Israel over other alternatives. The reasons for this were numerous, including the problematic nature of investing overseas, the lack of relevant professional knowledge, the high costs and the need to manage foreign currency risk. But after a not-too-lengthy review of tables showing the asset composition at Fund Y, which are similar to those in Migdal's other funds and those of other companies, we obtained a picture that is quite different than what was true in the past.
Of the tradable stocks in Migdal’s portfolio (23.5 percent of the total portfolio), for example, only 54 percent were listed on Israel’s stock exchange, most of them on the Tel Aviv-25 Index. The most significant local stock component was the stocks of Israel's five major banks. No less than 46 percent of the stocks were overseas companies. Which ones? Again, a surprise: The biggest stocks in Migdal’s D&O insurance portfolio were American tech giants, the ones discussed almost daily on TV and in the press. Google stock comprised no less than 1.7 percent of the D&O stock portfolio, followed by Amazon (1.5 percent), Apple (1.2 percent), Facebook (1.1 percent) and Microsoft (1 percent). Together, the five American tech giants make up no less than 6.5 percent of the stocks in Migdal’s biggest fund, second only to its holding in Israeli bank stocks (10.2 percent). Furthermore, Israeli pension funds’ holdings in these stocks is even larger than may appear, since they also make up part of the investment in foreign index funds and part of the investment in foreign hedge funds, which are also much sought after by Israel’s pension funds.
Surprising? That isn’t the whole picture regarding foreign investments by Migdal’s D&O insurance plans and other Israeli pension funds. When looking deeper into the details of ETF investments, which are 9.2 percent of Migdal’s portfolio, the vast majority (90 percent) track foreign exchanges, or in other words, foreign stocks. Migdal’s investment in funds, which includes venture capital funds, hedge funds and private equity funds, shows a similar picture, with 85 percent being foreign funds that invest mainly in stocks. These comprise around 10 percent of the entire investment portfolio, similar to Migdal’s total investment in Israeli stocks. All told, the investment in foreign securities amounts to at least 45 percent of the total. In other words, half of the portfolios of people saving through D&O insurance at Migdal are invested overseas, mostly in stocks, with a big portion of this dependent on the fate of a small number of technology stocks.
Not only Migdal
Is Migdal’s portfolio an outlier? It appears not to be. Nearly all the pension and long-term savings funds in Israel, at insurance companies or with investment houses such as Altshuler Shaham, Meitav Dash Investments or Yelin Lapidot, are similar in principle, with the differences among them boiling down to the specific choice of stocks.
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Altshuler Shaham Provident Funds and Pension, which in September 2021 held assets worth 2.5 billion shekels ($793 million), held 46 percent of its assets in stocks, almost 70 percent of these overseas. Prominent stocks it held were Nestlé (3.2 percent), Alibaba (3.2 percent) and Pfizer (1.5 percent). If one adds to this the 11 percent invested in foreign mutual funds and the 5 percent in overseas ETFs, one gets a portfolio in which 30 percent is still in cash or invested in Israel government bonds, but the rest is almost entirely comprised of stocks, mostly overseas ones. This is true for all institutional investors in Israel. This is how the long-term savings portfolio of each one of us looks.
This raises several questions: First of all, is such a composition of assets a problem? Since interest rates are at rock bottom around the world, and since the bond market has for some time not yielded positive real returns, investment managers have had to divert more and more funds from low-risk investments into stocks and stock-like investments, mainly the major U.S. companies that top U.S. stock markets, such as those on the S&P 500 index. But if these investments were the major factor behind the high returns of Israeli pension funds in recent years, this is a risky strategy. If there is a change in the trend in technology stocks on Wall Street, namely, if the high-tech bubble deflates, Israeli pensions will be hit hard.
Apple, Amazon, Microsoft and Google are trading at a valuation of close to $2 trillion each, but how long can this party last? Israeli citizens must understand that their standard of living after retirement is directly related to the price of these five stocks, and to the share price of Israel’s major banks, which are also a central anchor in the portfolios of most institutional investors.
We’re not like America
There are additional challenges stemming from institutional investors’ shift to stocks and overseas investments. One is the issue of currency exposure, since investors have to use the public’s shekels to purchase these stocks in dollars, and then pay returns in shekels, since Israelis live and spend money in Israel. As a solution, institutional investors tend to hedge their foreign investments against major shifts in exchange rates, but such hedging is expensive.
“Every dollar I buy overseas costs me 0.8% a year, almost a whole cent, in order to protect the portfolio from risks associated with exchange rate swings, and this comes directly off the portfolio’s returns,” explains a major investment manager at one of the large insurance companies, adding that this protects most of the portfolio against such rate swings. But not all the portfolio is protected. This means that when the shekel gains against the dollar, the return in shekels decreases.
Another problem is the inconvenient work hours on Wall Street for Israeli traders, and mainly, their insufficient familiarity with the companies traded there. In Israel, institutional analysts and researchers can speak freely and directly with company directors, visiting and getting their own impressions of factories or business operations, observing the body language of board members as they answer questions. In contrast, their access to managers at the American giants is non-existent. An Israeli analyst can quite easily gain access to the CEO of Bank Hapoalim, but not to Apple’s CEO Tim Cook.
So investment managers in Israel look for other solutions in order to generate returns. Some of them, such as Gilad Altshuler at Altshuler Shaham, make big gambles that sometimes succeed and at other times don’t. In the past, Altshuler invested more than others in shekel-based bonds that were not inflation linked, earning returns higher than his competitors’, after which he embarked on a massive campaign to recruit new clients. “Almost every shekel lost by investment houses, including ours, went to him,” says one of his competitors. But recently, he made a big wager on Chinese stocks and failed, due to a decision by China’s government to crack down on their own business giants, causing Altshuler to lose clients and money in recent months.
Other institutional investors divert money into real estate and infrastructure projects in Israel, but here too there are challenges. These projects are currently structured so that even if they yield returns of 6 to 8 percent, much of this remains in the hands of the developers, while institutional investors, meaning the public, receive only half of these returns, even though it’s the public that brings the big money to the deal. In this case, the one paying the piper is not the one making most of the profit.
There are also numerous attempts to deceive and mislead in managing pensions and savings. One of the better-known tricks is to create impressive returns through new investments, something that is relatively easy to do when investment tools such as provident funds, pension funds and mutual funds only handle very small amounts of money but which is impossible to scale up when the money grows to significant levels.
It goes like this: Open a new investment tool, such as a mutual fund. Market it to members, so that it attracts a few hundred thousand shekels, and use this money to buy small, non-tradable stocks. Continue promoting the fund and transfer money into it from other funds, so that it accumulates more money, which you use to buy the same stocks, thereby raising the value of your own stocks. From here, the machine starts to work on its own. The impressive returns attract new investors who deposit their money into the fund, which is used to buy more non-tradable stocks whose value keep growing, and the cycle continues. It all works wonderfully until the fund has an amount of money that no longer allows it to rely on a small number of small stocks, or until the asset composition starts looking suspicious, and the game stops. The small stocks lose their value.
But even then, even if the returns are no longer exceptional and are possibly disappointing, the fund can continue publishing its nice performance for years. If this fund showed a 50 percent gain in its first year, when it was tiny and full of manipulated stocks, it will surely perform impressively in three, five and even 10 years, one might believe. Are investors being deceived here? Of course they are. Is this illegal? Apparently not, at least according to the current interpretation of the Israel Securities Authority.
For investors, the rule should be simple: Unless you get in right at the beginning, beware of new investment tools with handsome returns, since this might be the same trick employed in the past by many investment houses when they were still small.
Another serious problem in the capital market is how insurance brokers work. These are people aspiring to look like financial advisers serving their clients, but in fact, they are agents working for the insurance companies and investment houses. Israel has many such brokers, more than 14,000. They go by different names, such as “retirement consultants” or “senior financial advisers,” and present themselves as impartial, since they work with all the insurance companies. In practice, this is mendacious. They work with many investment houses, but their one clear interest is to get a client to move from their current investment house to another one.
Ultimately, investment managers who work with institutional investors in Israel are all in agreement: For long-term investments, certainly when it comes to pension and retirement funds, the stock market is currently no more dangerous than the bond market or than anything once considered to be a solid investment, and investors have no option but to hold major stocks such as Apple and Google. That’s because they are the ones driving the American stock market, which in turn is driving all other global markets. This is the world that has arisen as a consequence of vanishingly small interest rates and the printing of money by central banks. The question savers should be asking themselves is what will happen when this new world reverts, possibly all at once, to the rules of the game as they were written in economics and finance textbooks for the last 200 years.