iShares MSCI Israel ETF: A Strong Recovery Play (NYSEARCA:EIS)

The iShares MSCI Israel ETF (NYSEARCA:EIS) caught my eye with a +2.64% rally on Monday, breaking above the July 2023 high. It has now rallied over +34% from its October low and is within +2.4% from exceeding the 2023 high.

Relative strength such as this is always worth paying attention to, especially when the outperformance is happening against a backdrop of negative sentiment. Due to the Middle East conflict, investing in Israel is seen as risky, but someone is clearly buying the fear and doing very well from it. Should we follow?

A Black Swan

The Hamas attack on Israel on October 7th was a Black Swan for the markets. It provoked the usual reaction – sell now and ask questions later. For EIS it caused a large gap down on Monday 9th and sharp move down into a capitulation bottom on 26th October.

A large drop was logical given the gravity of the situation, but the “V-shaped” reversal into a strong rally was less plausible. The entire fall had been recovered by the end of November.

The reasons for the recovery and rally can only be speculated on. An Israeli ground offensive started on the 28th October and could have helped sentiment. However, I don’t think one specific event triggered the turnaround. It seems the market gradually realized that Israeli companies might not be as negatively affected as first feared and buying was a better approach than selling.

EIS Exposure Risk

The Middle East conflict will affect different sectors in different ways. Travel, recreation and tourism will face headwinds. Security and defence may well benefit. Many other sectors may not see any effect at all. A look at EIS’s exposure suggests the majority of its holdings are unlikely to be directly affected.

Technology companies dominate. Many of these have a global reach and offices in the US and other countries. EIS’s largest holding, Check Point Software Technologies (CHKP), provides cybersecurity solutions worldwide and is listed on the Nasdaq. It has performed well since the October 7th attack and is trading at all-time highs. Companies like this should not be negatively affected.

Financials also feature heavily in EIS’s exposure, and Real Estate is the third largest sector. I’m less certain these will avoid all adverse effects, so a closer look is required. Here are the fund’s top 10 holdings:

52.5% of the fund’s 116 holdings are concentrated in the top 10. Local banks make up three of the positions and five of the top 20 so it is important these perform well under current conditions.

As it happens, the banks are the only holdings in the top 10 not to be listed on the NYSE so information is less easily available. However, they are listed on the Tel Aviv stock exchange and make up the top holdings in the Financial sector. This is how financials in Tel Aviv are doing:

The sector is trading in the top half of a large two-year range. There is no real sign of stress and if there was any major long-term risk from the conflict it would likely be reflected in the chart. That said, it has not yet traded above the early October 2023 high and with stock markets in many other countries trading at all-time highs, this shows relative weakness. I would feel more comfortable if the chart broke the 2023 high and consolidated above.

Other companies in the top 10 include the well-known Teva Pharmaceutical (TEVA) which is a global generic drug manufacturer. It has manufacturing plants in many countries and a large plant in Jerusalem, Israel which has not been affected by the war.

To conclude, there are numerous global companies in the fund’s holdings and these will insulate EIS from any downturn in activity in Israel.

Furthermore, the impact of the conflict on the Israeli economy as a whole has lessened. Data from the Bank of Israel shows a return to growth after a contraction in October and November.

Here is some commentary from the bank:

The Composite State of the Economy Index increased by 0.4 percent in December-reflecting the economy’s gradual recovery from the impact of the Swords of Iron War. The war continued in December, but its impact on activity continued to weaken.

The Index was positively influenced by increases in the Industrial Production Index, the retail trade revenue index (November), import of consumption goods, goods exports, the job vacancy rate, and credit card purchases (December). In contrast, services exports, employee posts (October), and imports of production inputs (December) declined, which negatively influenced the index.

EIS – Other Considerations

EIS is a passively managed ETF from BlackRock. As per the prospectus:

The Fund seeks to track the investment results of the MSCI Israel Capped Investable Market Index (IMI) (the “Underlying Index”), which is a free float-adjusted market capitalization weighted index that is designed to measure the performance of the large-, mid- and small-capitalization segments of the equity market in Israel. The Underlying Index is rebalanced quarterly using an optimization process that aims to minimize the constituent weight differences between the Underlying Index and the MSCI Israel Index (the “Parent Index”)

EIS pays a small distribution with a yield (TTM) of 1.35%. The expense ratio of 0.59% is reasonable but on the high side. My concerns are more with liquidity with a Dollar daily volume of $1.84M. This is a small fund with only $137 AUM.

EIS’s only real peer is the VanEck Vectors Israel ETF (ISRA) which has outperformed slightly but is more volatile. The reason I have not looked more closely at ISRA is that it has only $60M AUM and average Dollar daily volume of only $144k.

In terms of providing broad exposure to Israeli companies, EIS is the most liquid ETF available.

Risks

As we saw in October, a -17% decline can come out of nowhere. There is scope for the Middle East conflict to widen and risk of further attacks. I do think any fall should recover again, but the short-term losses could be challenging.

In the longer term, there is a risk Israel and EIS underperform. EIS was much weaker than US indices for most of 2023 which obviously had nothing to do with the October attack. Now that the snap-back rally has largely played out, EIS may underperform again.

Conclusions

EIS has made a strong recovery from the drop after the October 7th attacks. The international and Tech-based composition of much of the fund means there was a limited effect on the holdings. Furthermore, the economic impact from the war is lessening and Israel’s Composite State of the Economy Index increased by 0.4 percent in December. I’m not sure I would rush to buy after a 34% rally and with underperformance in Israeli Financials, but if there is a sharp dip again, EIS could be an interesting recovery play.