Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is senior director at the Jerusalem Institute’s Milken Innovation Center
Should cross-border benchmarks for stock markets be determined by geography or by the compatibility of the companies that make them up? That is the question facing MSCI when it is expected to consider this week how to classify Israel among the indices it compiles for investors.
MSCI is looking at whether to move the country from its Europe and Middle East index into a different one. This is a big issue for Israel. Inclusion in an MSCI index can steer billions of dollars of funds from portfolios that track such benchmarks.
When Israel joined the OECD in 2010, MSCI created an index specifically to reflect that “graduation” to developed country status — the Europe and Middle East index. The country’s stock market has paid a heavy price for this.
Instead of opening Israeli markets to global investors, the opposite happened. Many investors largely ignored the new index, seeing it merely as a revamp of the European index with a Middle East sidebar. As a result, Israeli markets were excluded from material investment research coverage and in effect placed outside the global investor community. The country took a massive economic hit.
Once a significant part of the emerging market index with a 3 per cent weighting, today Israel accounts for only 0.4 per cent of the MSCI World index.
Israel abruptly lost $2.5bn of outward capital flows caused by the MSCI index upgrade while foreign investment inflows fell. From 2010 to 2019, the average daily trading volume on the Tel Aviv Stock Exchange dropped 37 per cent from $547mn to $365mn. The market for initial public offerings ground to a near halt as delistings rose.
“Middle East” is a misnomer in markets that has no correlation to 21st century capital and technology trends, nor reflects how economies are integrating. Classification of Israeli markets as “Middle Eastern” does not capture, and in fact distorts, the reality of its global and inter-regional trade and peer trading partners.
As such, Israel’s trade and investment markets have much more in common with European and global peers than with some of the neighbouring markets.
Including Israel in MSCI’s geographically diverse Europe index would give Europe, as well as passive and active global investors, greater exposure to Israel, its role as a global nexus of successful and expanding tech hubs and its stable currency. The tech sector makes up only 8 per cent of the European index but 37 per cent of the Israel (Middle East) index.
Not for nothing has Israel earned the title “start-up nation”. The number of technology and growth companies in Israel has soared over the past decade.
In 2021, there was a recovery in IPOs with a flurry of new listings on the TASE. These provided investors with access to a trove of companies specialising in cleantech, fintech, food technology, cyber security and medical devices. These kinds of listings accounted for 65 per cent of Israel’s new issuances for 2021. Today, the country’s robust technology ecosystem ranks number one globally for start-ups per capita, according to research house IVC. It also ranks number two for expenditure on research and development as percentage of gross domestic product, according to World Bank data.
But many start-ups in the past just could not afford to stay and grow in Israel, with stock market trading liquidity limited by the current MSCI classification, which has given Israel a low-visibility position in an overlooked index. This has hindered Israel from growing into a “scale-up” nation within global markets.
In this decade, investors in the MSCI’s Europe index also missed out on diversification of investment with exposure to Israeli companies. The TASE 125 index has risen 61 per cent over the past five years, or 87 per cent in dollar terms, as the market has become more attractive to foreign investors. Over the same period, the MSCI Europe index has gained 32 per cent.
Israel’s corporate assets speak for themselves, and MSCI reassignment into its Europe index would be an important step supporting the financial infrastructure the country and its trading partners need to accelerate their growth.
Global investors should not group markets by physical geography alone. That does not reflect the partnerships positioning the world’s economy for sustainable prosperity despite the pandemic and climate change. These challenges require inclusive markets.
MSCI has undertaken the right steps as it weighs this reassignment — a move that more appropriately reflects Israel’s market status in a global orbit rather than one hemmed in by a fixed geographic designation dating back to a century ago.