The military and political situation in Israel has decimated the country's economy, sent its stock market into a tailspin and caused a major cutback in foreign investment, including in the once high-flying high-technology industry.
"The situation is of grave concern to everyone who invests in Israel," said Richard Watt, head of global emerging markets at Credit Suisse Asset Management, New York, and portfolio manager of the First Israel Fund, which has fallen to $49.9 million as of May 1 from $80 million in November 2000.
Most stock markets of emerging markets countries performed well in the first quarter; the Morgan Stanley Capital International Emerging Markets Free index was up 10.7%. However, the Tel Aviv Stock Exchange's Tel Aviv 100 index was down 15.1%. In U.S. dollar terms, it has fallen more than 30%, according to Mr. Watt. The Argentine market, the only emerging market stock market with worse performance this year, is down about 50%.
"There is no doubt that it's right to highlight the geopolitical risks as being a major factor in the problems of the stock market," said Mr. Watt.
"It's fair to say that any Israeli company has been negatively impacted, rightly or wrongly, by the situation in Israel," said Roger Sit, president of Sit/Kim International Investment Associates Inc., Minneapolis. The firm has about $40 million of its $1.6 billion in international investments in Israeli companies.
"The Israel market is very trading-oriented now," said Mr. Sit. "Its focus is on minutes and hours, not days and weeks. It's schizophrenic; it's a very nervous market."
During the first quarter, Sit/Kim sold its holdings in Converse Technology, Tel Aviv, a telecommunications company Mr. Sit said has gotten "the one-two punch from the bad situation in Israel overall, and from being a telecommunications infrastructure company." Sit/Kim still owns the stocks of Israeli companies Checkpoint Systems, Teva Pharmaceutical Industries Ltd. and Amdocs Ltd.
The First Israel Fund performed well this year relative to its benchmarks, Mr. Watt pointed out. The fund is down about 12.5% year-to-date through May 1, far less than the Tel Aviv stock market, which is down 21.5% through May 1, and the Morgan Stanley Capital International Israel index, which is down 16.5%.
Mr. Watt said his fund has focused on "smaller, defensive sectors such as domestic demand-focused companies" like mortgage banks and insurers. At the end of the first quarter, the fund's top 10 stock holdings included Harel Insurance Investments Ltd. and Bank Hapoalim Ltd.
Emory Brewer, portfolio manager of the emerging markets fund at Driehaus Capital Management Inc., Chicago, said the fund sold off its last investments in Israel during the first quarter. He said Israel "is going through one of its worst recessions in the last three decades."
Mr. Watt pointed out that short-term interest rates in Israel have risen to 8.5% in real terms. He also noted that tourism, which has been an important industry and a large source of foreign exchange, has declined sharply.
Mr. Brewer said there are a lot of Israeli high-tech companies that "reported very good numbers, met or exceeded analysts expectations, and the stocks are still not doing well." He wondered: "Is it because they're in the tech sector or because they are Israeli?"
The Israeli high-tech industry and the venture capital infusions that fed it already were burdened by the same problems that have affected the high-technology industry and venture capital investment worldwide. Now they have to contend with the political and military situation as well.
The political and military situation "has had an effect on several fronts; Israeli venture capital firms trying to raise new money have had problems," said Gerald Segal, managing director of Bear Stearns Israel, Tel Aviv. He pointed out some deals involving Israeli high-tech firms and foreign companies might not be getting done because of a reluctance by executives to travel to Israel to do the due diligence required for many deals.
Venture capital decrease
Venture capital investments in Israel in the first quarter of 2002 totaled $344 million, according to the Kesselman & Kesselman Pricewaterhouse Coopers MoneyTree survey of the Israeli venture capital industry; investments were $384 million in the last quarter of 2001. There was also a 28% decrease in the number of companies that raised capital during the first quarter, to 76, from the fourth quarter of 2001.
Tobias Fischbein, Israel technology analyst for Lehman Brothers, New York, said about $9 billion is invested in the high-tech industry in Israel, and he estimates that around 60% to 70% of it comes from U.S. investors.
Among pension funds investing in venture capital in Israel are Caisse de Depot et Placement du Quebec and the New York State Common Retirement Fund.
Montreal-based Caisse, Canada's largest pension fund, with C$125 billion (US $71 billion) in assets, has invested "between C$10 million and C$30 million" in Genesis Partners, a Tel Aviv high-technology firm, according to spokeswoman Lucie Freniere.
And the $112 billion New York state fund, Albany, has $25 million in venture capital investments in Israeli hi-tech companies and $68 million in State of Israel bonds, which are used for economic development projects, according to Jeffrey Gordon, spokesman.
Advent International Inc., the Boston-based international venture capital firm, has had a subsidiary in Israel, Gemini Management Co., since 1993. Gemini recently closed its third fund, totaling $200 million, according to Stephen Kahn, managing director of Advent.
"The venture capital market in Israel is directly tied to the venture capital industry in the United States," Mr. Kahn said. "When there are problem issues in the U.S., there will be problem issues in Israel."
But there may be a hint of a silver lining. The severe downturn of many companies on the Tel Aviv stock exchange has caused Mr. Watt to consider picking up some bargains for his fund. "We're thinking about investing in companies that have been beaten up over this period," he said. "We're looking at some strategies that would suggest a more aggressive stance."