Why You Didn't Make 900% on Stocks

Last Wednesday, at 17:15, the TA-100 index crossed the 1,000-point mark.

No, no need to stand to attention. That landmark is totally meaningless, economically speaking. It does however constitute a neat point to take stock of Israel's long-term economic prospects.

In January 1992, the TA-100 index was reset at 100 points. In fifteen years, we learn, the Israeli stock market achieved nominal returns of 900%. If we adjust for inflation, the real return is 360%, which is 11% a year.

Did your portfolio return 360% in the last 15 years? With all due respect to your investment savvy, we surmise that it did not. (If it did, write me at guy.rolnik@themarker.com.)

Seven reasons you didn't make 900%

1. You aren't in stocks at all. When the bank stocks crashed in the early 1980s, much of the public fled, and the ones that came back got burned in 1994, when the stock market lost half its value inside a few months. In short, the Tel Aviv Stock Exchange never regained its legitimacy in many eyes.

Many people are indirectly invested, but their holdings in stocks are small, and so are their resultant returns.

The good news: The TASE has been regaining its legitimacy as an investment avenue, and it should have done. The stock market today is deeper, more liquid, broader, more professional. Like any financial market, it's vulnerable to bubbles. But it's gradually becoming more advanced.

2. You hop in and out. That 900% in 15 years looks good, but the chart shows that the gains were achieved in ten or 20 bursts of action, each lasting a few months.

Few investors have the discipline to get into stocks and stay there. They hop in, stay a few months or years, and get out. Some are talented at buying at the peak and fleeing at the dip. If you fled the market when times turned tough, you lost hefty chunks of that 900%.

The good news: The Israeli public didn't hare for stocks as they soared in the last three years, but conversely, it didn't flee when war broke out on the northern border last summer. Most of its investments are done via institutional investors, and the fluctuations by entering/dumping have been dampened.

3. You got bad advice. For decades, Israel's citizens received dreadful investment advice from people they trust: the investment advisers at their banks.

They aren't really advisers: they're marketing what the bank finds convenient. Their incentives, direct and hidden, led them to pitch bad investment instruments. When the stock market was rising, they pushed bank funds that lagged behind the market. When the downturn came, they pushed fixed-income funds (also run by the banks). When the dollar rose, they plugged dollar instruments.

Every time the wheel turned on the market, they urged you to do something else and pocketed fees on each action.

The good news: The Bachar reform has fundamentally reformed investment advice at the banks. Its quality has been improving fast. Advisers still have plenty of conflict of interests, and not a little regulatory intervention is still needed. But the client's situation is much better.

The bad news: Many investors at the banks are now pushing investors towards new-fangled types of mutual funds that invest in corporate bonds. They look solid enough in a bull market, but they'll look a lot less solid when the downturn comes.

4. The Israeli capital market was closed to the world, until a few years ago. Tax discrimination, supervision over foreign currency movements, anachronistic investment regulations and a shortage of real information prevented you, and the institutional investors managing your money, from investing some of it abroad.

Investors who hated the risk in Tel Aviv stocks had no choices, but to simply own less Tel Aviv stocks, but they couldn't buy stocks from other countries. Their returns were commensurately low.

The good news: Today the capital market is wide open. Inside a few hours you can build a diversified portfolio spread over numerous stock markets, and you don't even have to get out of your chair. Most of the tax barriers have been razed, supervision over foreign currency is gone. The market is open.

5. You paid sky-high fees, and get bad service. Look at the returns that most of your holdings in mutual funds and long-term instruments achieved. At best they achieved 80% or 90% of that 900% that stocks made. Usually they achieved half that or less.

Why? Because most investment managers weren't worth the management fees they charge, which typically run at 2% to 3% of your assets. That really gouges holes in your returns, too.

Regarding management insurance (bituach minahalim) and provident funds, though they're long-term instruments, most were run like short-term assets with very low stock components.

Many institutional investors treated their investors like captives, and charged enormous fees for mediocre investment management. The insurance companies are stars at that.

The good news: The stocks component in portfolios has been increasing. Yes, the risk is higher but so are the potential returns in long-term cases of 15 years or more.

Even more important: The percent of captive clients has been dropping fast because of the reforms in the pensions market, the mutual funds, and the provident funds. Other than NIS 100 billion locked up in lousy insurance programs, almost everybody with a financial portfolio is free to choose a new investment manager based on performance and service.

6. Until the 1990s, the government and the banks were the true powers in Israel's financial markets. Their domination depressed the development of the capital market and led to poor resource allocation. Foreign money went to the entities that controlled clients or taxpayers, not to entities that actually delivered good performance.

The good news: the government almost entirely out of the capital market, after it stopped issuing designated bonds to pension funds, and started scaling back its deficits. The banks are still enormously powerful in the financial market, but they don't manage investments any more and there share in the loans market has been shrinking like ice in Gehenna during the last three years.

The bad news: A bubble has been growing in the sector of corporate paper. Investors are taking on growing risks, sometimes unwittingly. One reason is that the appetite for risk has been growing in world markets.

7. You. You don't think for the long-term, and rightly so. You look at the way the Israeli government has behaved in the past. You see charlatanism, cynicism, corruption, an inability to see past next week. Given the cultural and governmental environment, how can you think in terms of 15 or 30 years? So you think in short-run terms, and people who think that way don't achieve 900% returns in 15 years.

The good news: Yes, Israel's governmental system is collapsing, but more and more companies listed on the Tel Aviv Stock Exchange are venturing into international markets, and are less and less exposed to the foul fruits of the government's achievements. Investor confidence in the Israeli business sector and in its big companies is significantly greater than its confidence in its leaders.

The bad news: The gap between the quality of management in the business sector and in government could grow wider.