Israel Is an Emerging Market Ignored by the Herd

Popular destinations for U.S. investors have been countries with vast natural resources, such as Russia and Brazil, as well as emerging new economies like India and China. To meet the record demand, a slew of investment products have been introduced, with funds like Market Vectors TR Russia ETF (RSX), iPath MSCI India Index ETN (INP) and iShares MSCI Brazil Index Fund (EWZ) making buying these once-obscure markets as easy as buying General Electric (GE).

As is our custom at Tradecraft, we try to look beyond the widely owned names beloved by the herd. To that end, I've become increasingly invested in a number of Israeli stocks, which have demonstrated a quiet outperformance that investors world-wide should envy. Over the past two years, the benchmark TA-100 of Israel's 100 largest stocks is up more than 60%. The currency, the shekel, is near a seven-year high against the U.S. dollar. Not bad for a tiny country in the Middle East that's smaller than the state of New Jersey and surrounded by hostile enemies that are constantly calling for its destruction.

To some extent, the country's economic growth should come as no surprise. Israel's economy is highly entrepreneurial and its work force is extremely educated. Israel has the largest number of start-ups in the world outside the U.S. It produces more scientific papers per capita than any other nation and has one of the highest per capita rates of patents filed world-wide. It ranks third in research and development spending in the world — quite impressive for a country of just seven million people that's only been around since 1948.

Yet, whether it's fears over regional conflict or simple ignorance, it doesn't appear as if Joe Six Pack has yet gotten on board. Turnover in 2006 on the Tel-Aviv Stock Exchange averaged about $326 million a day. For comparison's sake, in the U.S., shares of Cisco Systems (CSCO) alone trade more than four times that dollar amount.

And even amid the increasingly global investment game, getting proper exposure isn't easy. Just look at the composition of iShares MSCI Emerging Markets Index (EEM), a popular ETF that tracks emerging markets world-wide. South Korean stocks account for more than 15%, Chinese equities make up 11% and South African and Brazilian stocks both amount for roughly 10% of holdings.

Israel stocks make up less than 3.5% of the fund, ranking near Indonesia, Chile and Thailand, even though Israel's per-capita GDP beats them all. To that end, a U.S. investor seeking to gain exposure to Israeli assets has a small but attractive list of options to consider. Here are a few of my favorites:

The most well-known and widely owned is undoubtedly Teva Pharmaceuticals (TEVA), the largest generic drug company in the world with 2006 sales of more than $8.4 billion, 80% from North America and Europe. This diversified pharmaceutical company, headquartered in Israel, boasts a 1% dividend and is up over 25% year-to-date.

More off the beaten path is Bank Hapoalim (BKHYY), the largest Israeli bank, with a world-wide presence and more than 10,000 employees. Once owned by the Israeli government, the bank runs 250 branches in Israel, as well as in Europe, North America and the Cayman Islands. Shares aren't listed on a U.S. exchange, but on the over-the-counter "pink sheets" via a Level 1 ADR program. Depending on your broker, this can make shares difficult to trade, and virtually impossible to quickly flip. Shares were recently hurt by lower-than-expected earnings along with a negative Merrill Lynch report and concern over restrictions placed on a controlling shareholder. Still, those adventurous enough to take a position have been rewarded: The stock is up over 15% this year.

RRSat Global Communications Network (RRST) is a satellite transmission and production company that provides broadcast service to more than 285 television channels and 90 radio channels in 150 countries. Many of their customers you'd recognize, such as Fox News and NBC, while others like Turkish Radio and Kurdsat are lesser known to U.S. audiences. Forty percent of the firm's revenue is from Europe, while 20% comes from North America. Despite record results and a recent write-up in an American newspaper, only 17 large institutions report holding this $335 million company. Shares, which went public on the Nasdaq in November, are up more than 60% in the last six months.

While it's not exactly competing with the private-equity behemoths like the Blackstone Group or Carlyle Group just yet, adventurous investors might want to check out shares of Ampal-American Israel (AMPL), which owns a number of business interests in Israel.

Founded in 1942, the company's investments have changed over the years, but currently it boasts a 12.5% interest in East Mediterranean Gas Company, which is building an underwater pipeline to export natural gas from Egypt to Israel. Given the dramatic valuation expansion in utilities and other infrastructure holdings in recent years, this is an attractive asset in a rapidly growing part of the world. Other assets include a 100% ownership in luxury retirement centers, shopping malls and country clubs. This thinly traded name is up about 10% year-to-date.

And while there are no Israeli ETFs, those uncomfortable in picking individual stocks might be interested in First Israel Fund (ISL), a closed-end fund that has traded on the American Stock Exchange for almost 17 years. In addition to Teva Pharmaceuticals, which accounts for 9.41% of assets, major holdings include financial companies like Bank Leumi (5.21%), Israel Discount Bank (2.84%) and Harel Hamishmar Insurance (7.48%). The fund yields 0.80%, trades at a slight discount to net-asset-value and is up about 15% this year.

Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC. At the time of writing, Hoeing's fund held positions in many of the securities mentioned.