Mutual fund companies are complicated organizations, as are the people working inside them.  Mutual fund companies are primarily marketing organizations focused on gathering assets by promoting investment returns, which are then underwritten by the investment management team. As a result, there is pressure on mutual fund managers to perform with hyper focus on the return game, while at the same time needing to devote considerable time to marketing activities. This dichotomous tension results, in the best case, of valuable time wasted by investment managers on marketing activities; and in the worst case, in the launch of “fad” mutual funds from driving using the rear-view mirror.

The second aspect is the choice of mutual fund companies, the correct product within the myriad of choice, and lastly to be managed by the right manager.

The wrong investment house might be in the process of being silently acquired by another company, leaving staff more concerned in updating their CVs than servicing clients.  The wrong investment house might have a tendency to cremate their funds that blew up, never to be seen or heard from again.  Or perhaps to  silently reclassify their poorly performing investment funds into easier peer performance categories in order to whitewash them.  Or more commonly, they might be radio stations that always seem to be playing the newest song in town.

The wrong product is more nuanced.  Investors want the highest level on investment management and this is simply the firm with the best investment ideas and the managers who know how to execute on these ideas on risk/reward constraint.  It is very difficult for an outsider to choose the right product from the large product menu that most firms offer.  All too often, the investor chooses badly, and watches haplessly other funds within the same firm that provided better returns.

Mutual fund managers are severely limited by regulation and internal compliance from trading on their own account.  However, the best investment advice from a mutual fund manager is the answer to this question, “Which fund from your fund family would you invest in?” The answer to this question is worth money in the bank. Why? Because the mutual fund manager – due to compliance – might invest his own personal money in mutual funds as the least regulatory problematic option and which funds does he know the best? The fund he manages, as well as those of his colleagues – this is legal inside information at its best.  He knows which investment teams are struggling, which funds might have toxic assets or even hidden assets, which sector is most promising on investment merit and not marketing hype.

The last point is size. Smaller funds have an advantage over larger funds. It is far easier to navigate a small boat than an ocean liner. When managing large funds, the investment choices are initially screened for liquidity.  No matter how compelling the situation is, if it would be impossible to accumulate a decent position, it is rejected.  The cost of building up a position without moving the price is also a factor on the entry, but even more so on the exit side if there is a need to sell due to change in investment or unforeseen redemptions.  Here is the key takeaway – I would even request this be referenced in my name –

“Within a mutual fund family, a smaller mutual fund will usually outperform the larger mutual fund when operating under roughly similar objectives.”

This is important for a number of reasons.  Typically, the small fund will be serviced by the same research team as the large fund.  When new investment ideas are produced, the small fund might piggyback on the larger fund’s buying power, thereby providing an almost implied “put” option to its holding.  The smaller fund will typically have a lower management fee in order to entice investors and will also have an advantage in being able to accumulate positions more easily without incurring frictional trading costs.  Further, often there are funds which are similar but might have different names or classes, and only a forensic analysis of holdings will yield the golden nirvana of the best investment management of the firm in the lowest cost wrapper.

Lastly, smaller funds outperform, but when they become big funds, they find it more difficult. This holds especially true in Israel, where the top performing funds have beaten the larger funds, and based on their stellar returns have now become the “big boys.”  These firms are now awash with new funds, with their back offices flooded with capital flowing in as their funds take top position on 1, 3 and 5 year performance tables.  The fund flow has catapulted these firms’ assets and the ability to rely on past performance is diminished, because the new fund is growing by leaps and bounds every day and the manager’s main job is to deploy these assets as quickly as possible, as his portfolio becomes diluted by the new cash.  Likewise, his time is now even more stretched by marketing activities as the demand to present to banks and advisers is greater than ever.  This is a far cry from the situation a few years ago and as such the product is unalterably changed. Whether the firms manage this growth is not the mutual fund investor’s problem, he is not a shareholder participating in the growth of the mutual fund firm.  But qualitatively the firm and product have changed, and for top-performance ranked mutual funds, the warning “past performance does not guarantee future returns” resonates even more strongly.

The information on this site is not intended as and does not constitute investment advice or legal or tax advice or an offer to sell any securities to any person or a solicitation of any person of any offer to purchase any securities or investment products.

The Israeli pension system is designed for an employee who is on the “40-year plan”, staying with the same employer for the full course of their working career. Unfortunately, this system clashes with the reality of the ever-changing global environment which results in wholesale shifts in industries and diminishing job security for most employees outside of the public sector.  This is further exacerbated by the necessity of opening a “new” policy with each new employer and regulatory changes, such that, one can easily accumulate 10s of plans/policies by retirement.

When changing jobs, the first factor to be aware of is the cessation of payments to your pension plan. The pension plan is comprised of 3 components: retirement savings, life insurance and disability insurance.  The retirement components will remain as savings for future retirement, however as contributions have stopped the projected annuity payment at retirement will be impacted by the length of non-payment period.   Fortunately, the insurance components will remain in effect for 5 months after your termination date.  This insurance is vitally important, and even when unemployed you want to maintain coverage for you and your family.  The premiums for this policy will be paid from within the policy for the first 5 months.  Following this period you will be offered the opportunity to extend this coverage for an additional 24 months.  The premium for this coverage can come from the savings in pension or paid via direct debit.

When you are starting your new job, you are legally allowed to choose the pension product, i.e. keep your existing policies.  However, your new employer will need to sign off on your choice of pension and direct all contributions to your pension as instructed.  All contributions from your new employer will be shown separate from the contributions of previous employers, albeit in the same pension plan.  There are various issues regarding tax planning, severance pay and pension plan options that are outside the scope of this article and require professional advice from a licensed agent.

The level of risk is typically defined as the percentage invested in equities. Investment in equities is risky, and according to the studies there is a direct link between risk and return such that the greater the risk taken on the higher the return. Traditionally the equity allocation depends on the age of the saver with younger savers choosing higher equity allocations and lowering as retirement age approaches.

It is important to understand that the higher average returns for equity market investing is only true for the very long term.  Below are the historic returns for 3 common asset allocations (Source Vanguard).

The second column of the table shows bedrock of asset allocation, equity investment over the very long term 1926-2014, albeit risky, provides for a higher average annual return.  However when examining the 15-year period from 2000-2014, we see the opposite is true!

In practice, in Israel most savings are invested at medium risk in a “one size fits all” strategy in effect the average for all ages.  This means that this strategy is good for the average but does not really fit anyone at the individual level.  The effects of this was most pronounced in 2008, when many savers approaching retirement saw their lifetime retirement savings drop by 10% or more.

Selecting the best options for a retirement portfolio is important and the average is not good for everyone.  Equity market investment is volatile and the personal circumstances of the saver including age, financial profile, and risk tolerance need to be taken into account.  But more importantly understanding the true picture of the asset allocation behind the “average” and whether it is appropriate for the individual saver is vital.

There are many ways to save and invest money in Israel, in the article below we will outline a few of the most popular.

Bank Deposits and Bank Savings Plans (תוכניות חסכון)

This is the classical way for saving money due to the very low risk and protection of principal.  The rates offered vary by the size of the deposit and time length chosen to lock in the funds.  Further some of the smaller banks offer more competitive rates than the larger banks.  The disadvantages of this type of investment include lack of liquidity, low rates of interest, taxation, lack of choice and flexibility in terms of investment options and terms.

Managed Investment Accounts

A managed investment account is suitable for clients who want the security of funds remaining in their own name in their own bank account along with the transparency of knowing exactly where their money is being invested.  The type of investments held can be custom tailored to personal circumstances and risk profile and can be altered at any given time in consultation with the investment manager.  Fees for managed investment accounts compete favorably with mutual funds but typically there is a minimum account size. Investment managers are regulated by the Israel Securities Authority and have various compliance and internal controls ensuring client’s interests are protected.

Insurance Company Savings Policy (פוליסות חיסכון פיננסי)

Insurance company savings policies offer a wide range of investment options and flexibility to savers of all sizes and types.  Typically a lump sum is invested along with monthly contributions into a savings policy that is invested according to the preference of the policyholder following consultation with the insurance agent.  A core advantage of these policies is that tax is only paid at the redemption of policy allowing deferral of taxes yet policies can be redeemed at any time.  Investment options are wide while account minimum is low.

One of the confusing retirement products in Israel is the popular Managers Insurance or Bituach Minhalim.  This is retirement savings policy that typically includes life insurance and disability insurance.  The amounts contributed are a function of monthly salary and this premium is allocated between retirement savings and insurances depending on client needs.  Unfortunately, the policy details and statements are confusing and professional advice from a licensed agent is necessary.  However, the essential takeaway is that the policy combines retirement savings, life and disability insurance specific to the clients requirements.

The most interesting thing about Bituach Minhalim, and this is unique to Israel, is the fixed annuity payout ratio, in Hebrew this is called the “mikadem.”.  The mikadem is in effect the divisor used for calculating the monthly payment at retirement age.  The mikadem figure is how much funds are needed to buy 1,000 shekels a month for life.  A mikadem of 200, means it would cost 200,000 shekels to buy an annuity that would pay me 1,000 shekels a month for life.  To illustrate, if I saved 1,000,000 shekels at retirement in a policy with a mikadem of 200, then I would receive 5,000 shekels a month annuity for life.  This is in stark contrast to a pension fund which has no guarantee of monthly annuity, rather there is aprojection of expected pension payment but this is subject to the overall pension fund performance including actuarial risk.

What makes this product so newsworthy is that the older policies were using mortality tables with lower expected lifespans, in effect mispricing the risk or futusre payout, and rendering these policies to be valuable.  Further, life expectancy has been on the rise, approximately one additional year each decade, making these policies even more desirable. Fearing a insurance company solvency crisis, as the liability for these older polices can be staggering, the Insurance Commissioner prohibited the marketing of these policies with a fixed mikadem.  Incidentally, these policies have very high management fee, often explained away as the cost of the mikadem.  To clarify these older policies are no longer available, only existing policy holders are allowed to contribute.

If you have an old bituach minhalim policy it is vital to consult with a licensed insurance agent to properly understand its terms and condtions and what to do regarding contributions.  In addition, the Insurance commissioner has recently enacted provision to allow moving policies from one company to another, in an attempt to foster competition and lower the extortionate fees on some policies.

In any event, the article above is to provide general picture, always consult with a professional agent.

The majority of retirement plan assets across all product categories, pensions, manager’s insurance and provident funds are invested in the general or clali investment option.  This typically has a balanced one-size-fits-all investment allocation, with the equity weighting ranging from 25-40%.  However, the needs of a 25-year old worker just beginning his career are vastly different than the 60-year old worker with retirement only a few years away.  As a result, the Insurance Commissioner proclaimed that from 2016, all retirement plans will have investment options based on age:

Under 50 years old

Between 50-60 years old

Over 60 years old

Automatic age selection

These new categories replace the general or clali investment option. However the other investment options available such as fixed income only or equity only. Interestingly, this might make it more difficult to compare returns between insurance companies or investment houses, as the long historical track records of this option comes to a screeching halt at 2016.

The rate of change in Israel’s savings and investment environment almost matches the frequency of elections and the underlying instability of the region. Every 2-3 years new rules and regulations are promulgated and new savings and investment products are introduced. Typically, the various governments in power employ a trial-and-error approach, with the law of unintended consequences shining brightly in the rear-view mirror.

A potential example of this was the emasculation of provident funds, a popular savings vehicle almost a decade ago. Provident funds were savings accounts suitable for longer term tax-free savings, investment for minors, and supplementary retirement funds. When in 2008, new rules removed their attractiveness, investors diverted these funds into real estate investment, further fueling the bubbling market.
Now, the Government, is soft pedaling back on this reform from 2008, with the re-introduction of the familiar provident fund with some new frills. A provident fund is a collective investment vehicle similar to a mutual fund, investing a wide range of assets (stocks, bonds etc), but have tax advantages on the deposit and on the profits, but crucially cannot be redeemed without penalties until retirement.
The new version of provident funds, “Investment Provident Funds”, will most likely invest in similar investment options, but crucially allow for redemption at any point without onerous penalties. However, if redeemed prior to age 60, ordinary capital gains tax will apply. This allows for the Government to remain true to its goal of encouraging retirement savings, while not overly penalizing redemption. In a worst-case scenario of early redemption, the saver will have at least achieved a benefit of deferring taxes, while paying ordinary capital gains tax. Further, partial redemptions are allowed and I would expect the investment houses to readily offer loans against funds for savers interested in safeguarding capital gains from taxes.

In any event, this new product, when formally launched this year, is a welcome addition, and brings back a much-needed vehicle for tax efficiency.

The information on this site is not intended as and does not constitute investment advice or legal or tax advice or an offer to sell any securities to any person or a solicitation of any person of any offer to purchase any securities or investment products.

The Provident Fund for Investment (PFI) allows savers to deposit up to 70,000 shekels per year into a provident fund and is designed to entice additional retirement savings.  A provident fund is a collective investment vehicle that earns interest, dividends and capital gains free of tax that until now was only withdrawable at retirement without onerous penalties.   This new type of provident fund allows for withdrawal at any point in time, but with the payment of 25% capital gains tax that would have been paid in any event on ordinary savings.  However if the saver can hold off until retirement age, the provident fund can be withdrawn tax-free as an annuity.

The new Provident Fund for Investment is similar to traditional provident funds in that there are a myriad of investment objective options that a saver can choose, from conservative to aggressive.  Moreover, switching between investment objectives is not a taxable event and typically there are no switching costs.  A compelling feature is the ability to switch between provident fund managers without incurring tax liability.  This is a core advantage over the current insurance company saving policy product whereby a saver is compelled to sell his or her policy in order to switch to a better performing investment manager.  A second key advantage over the insurance company product is the lower management fees versus the insurance company saving policy product which typically costs 1.2% annually.

This new product also finally provides a sensible way for gifting to grandchildren and investing bar/bat mitzvah gifts.  The child’s name can be entered as the account holder with a “custodian” family member and the funds can be invested in more attractive alternatives.

In summary, the PFI funds provide a compelling opportunity for savers, seeking to alleviate the tax burden, with the worst case being a deferral of taxes and reinvesting profits, and the best case the funds being used for retirement and pulled out tax-free.

As the curse or blessing goes, “we are living in interesting times.”  We have seen interest rates go below zero in major currencies, while major government and safe corporate bonds are yielding less than 2%. The unprecedented pumping of liquidity in a coordinated action by the global central banks has created an environment of There Is No Alternative (“TINA”) whereby investors are pushed by the zero-interest rates into higher risk investments by force.   This new market phenomenon of investors paying a government, bank or even a company to hold their money at a negative rate of interest is unprecedented and goes against the first rule of finance – the time value of money.  This has rendered classical investment models and strategies useless and has made many economics textbooks redundant.  Many leading market pundits have warned about the eventual need to unwind this government intervention and return interest rates to a more normal level.  However, the fear of deflation and slowing economic activity has pushed out these fears (“kicked the can”) each year as government balance sheets continue to balloon with endless printing of money, causing a scramble for assets such as stocks, bonds and property.  As a result of this forced buying, current market valuations appear expensive and as a result projected long-term returns are unfavorable. The net result of this means that as asset managers we have had to work doubly hard, to look more broadly at all viable asset categories while increasing diligence on quality and concentration on capital preservation to avoid being seduced with the crowd and to protect our clients’ assets.

Our primary focus, as you are aware, is the Israeli market, and interestingly, Israel has not been a major player in this global economic story; as Bilaam prophesized, we as a nation reside alone. This massive global intervention is fighting the effects of slow growth and deflation being caused by household balance sheet correction from the crash of 2008, increasing technological displacement and demographics.  Interestingly, Israel has suffered from none of those events.  Israel weathered the financial crisis due to its antiquated banking laws from the 1950s which hampered securitization and kept underwriting tight (for household sector as opposed to corporate/tycoon sector!).  Technology is the most important part of the Israeli economy and is a source of job creation and growth, not economic devastation, compared to Detroit as an example.  Lastly, demographics, well above OECD birth rate and consistent immigration.  These factors combined have rendered Israel stronger in relative and absolute terms with steadily rising GDP per capita and is manifested by the shekel appreciation.  We can proudly say that our portfolio is Israel dominant, and we have bought on behalf of you, our clients, millions of shekels, and invested in Israeli bonds and equities.

We hope Israel continues to grow from strength to strength and wish you, our clients and your families, a happy and healthy new year.

Moshe Klempner