Investing in shared destiny - Part I | Michael Freedman

CONTEXT

Next week, the annual General Assembly of the Jewish Federations of North America will come to Tel Aviv for the first time in its history.

Below is a full “white paper” with more technical information, but here is a synopsis by way of introduction to the subject of investment by the JFNA and Diaspora Jewish organisations in Israel, and our proposed solution to a rather complex issue.

SUMMARY

The JFNA’s endowments and foundations manage some $20bn of assets, which are invested in all manner of funds and products globally. However, a surprisingly small amount is invested in Israel, despite the prospect of compelling financial returns, the benefit of portfolio diversification, and the impact aspect of strengthening Israel and its relationship with the Diaspora.

There is no concerted strategy to change this reality, and there are currently no funds that can provide the risk-adjusted, institutional-grade opportunities across asset classes in Israel that suit a Federation endowment, and no single one has the financial firepower to create one efficiently on its own, given a sensible allocation benchmark of 2% of assets. It requires several to move together.

There are ample reasons why such an effort would be welcomed by all. Despite stellar economic growth, and almost every asset class performing well in recent times, the average Israeli is struggling on a day to day basis. Only systemic, large-scale investment, coupled with appropriate market reforms and new financial products and strategies, will change the socio-economic reality. Doing so will unlock massive economic value for both Israelis and whoever has provided the capital.

We believe that it is in the Diaspora Jewish community’s interests, led by the JFNA as its largest organisation, to drive and fund this process. The twin motivations of reaping the financial reward, with proceeds funding Diaspora Jewish life, and sowing the seeds of Israel’s next growth phase, are perfectly aligned, and the timing is absolutely right.

We have created a detailed solution to support this, and at next week’s GA we plan to hold open discussions to iron out a suitable structure to create a vehicle that can deliver on this. This being a project that is in the national interest and that of world Jewry, a non-profit partnership with the JFNA and its member organisations offers the best path forward.

In short, Diaspora support of Israel currently balances on two pillars – philanthropy and advocacy. This is a unique opportunity to add a third, stabilising pillar of investment, which reflects a new paradigm of the Diaspora-Israel relationship, the incredible achievements of Israel in the space of 70 years in building a stable economy, and all the potential for further growth and dynamism that is waiting to be unlocked.

In a recent series of articles ahead of this, Yosef Abramowitz explained where the Diaspora-Israel relationship is, and the JFNA’s particular position.

CONTEXT

In the first, he articulates the sense of drift between Israel and North American Jewry that is rapidly becoming a full-on rift, driven by the Kotel dispute, the continued rejection by government ministers and rabbinical authorities of non-Orthodox denominations, the Nation State Bill, and the increasing partisanship in American politics over Israel, as the Republicans and Trump double down on their support, and many Democrats are more vocal about their concerns and criticisms. He points out that the Jewish community has worked out how to lobby effectively in America but not Israel, and even Israeli government officials are surprised at this.

In the second, he describes the increasing irrelevance of the JFNA or what American Jews think, in shaping Israeli policies or politics, despite their perception that the combination of their philanthropy, advocacy on behalf of Israel, and the second-largest Jewish community in the world, should give them a seat at the table. He pulls no punches in explaining that with the next JFNA CEO, there will need to be a new direction and vision, and it must involve Israel in a different way. In reality, 19 Federations raise 80% of funds, so the decision-making power lies in a small circle of managers and leaders.

In the third, he decries the inability of the Federations to use their immense financial firepower as a strategic tool to enhance their relationship with Israel, strengthen the state both in domestic infrastructure and opportunity, and through innovative projects abroad, and make a solid return for their foundations and endowments. He gives examples of impact investment that could deliver on these.

THE FINAL PIECE OF THE PUZZLE

I cannot disagree with any of his conclusions. What is missing from here though is a model for execution, to deliver what is in the interests of Diaspora Jewry, led by the JFNA, without impinging on Israel as a sovereign state, whilst supporting its ongoing development and spurring massive growth to resolve Israel’s socio-economic issues, all whilst making a positive financial return for the Federations’ foundations and endowments.

In turn it must be done in a way that complies with the latter’s fiduciary responsibilities, and can navigate the disparities between the financial, strategic and philosophical needs of more than 130 individual Federations and their underlying foundations and endowments.

This is the kind of macro solution that takes years to develop. Fortunately, this is exactly what we at Asquith Israel have been working on since 2011, when I attended my first GA in Denver. This is the first time we have gone public on our proposals, as we believe the time is right to do so for a variety of reasons, and it is not something that we can deliver alone.

It requires enormous support from the Israeli government, Diaspora Jewish organisations and their leadership, investors and philanthropists, and a whole host of investment professionals in Israel and abroad.

A WORK IN PROGRESS

Firstly it is important to explain something about the practical limitations that have prevented this happening already, regardless of the will of any individual Federation. The vast majority of the nearly $20bn of assets under management across the 100+ endowments is managed by third party companies, although almost always under the supervision of a board or investment committee established by the specific Federations. Their fiduciary responsibility is to provide the best risk-adjusted return for their clients.

Much of this is invested in a variety of asset classes and funds that give exposure to domestic and global markets; Israel – despite being an attractive Developed Market – is generally weighted well under 1% of equity and fixed income allocations of these endowments. Many thought-leaders in this area (such as BlueStar Indexes) have pointed out that, since Israel’s graduation to Developed Market status in 2010, due low weighting it is usually minimally included in the index-based and actively-managed funds that are used by these endowments.

Furthermore, Arab and Muslim countries such as Qatar, the UAE, Malaysia, Pakistan and Indonesia represent a significantly-higher weighting in those same portfolios, and additional indirect exposure through to those countries is acquired via investments in energy and commodity sectors such as oil and gas.

This is how, as pointed out in Yosef’s third article, more Federation money has been invested in Israel’s enemies than in Israel itself. It is harder to correct this than one might think; divesting from aspects of a portfolio comes with high costs, and may drive down overall yields (remember, managers have binding responsibilities to generate the best returns they can, and that income funds the Federations’ spending).

The second part is to divert that recovered amount, and/or allocate specifically, into the Israeli economy instead. Here the problem is that by global standards, Israel is a relatively small market, with all the inefficiencies this entails as a place to invest. Only in the start-up world does Israel punch seriously above its weight, but unsurprisingly, as a higher-risk and very illiquid asset class, it can only ever represent a small proportion of a conservative endowment’s portfolio.

The only way to resolve the scale conundrum is, in simple terms, to look at Israel as a whole as the asset class, aggregating all of the information necessary for decision-making in a single platform, with sample portfolios, execution, oversight and reporting capabilities – a “supermarket” of Israeli assets, if you will. That allows the allocation to be sufficient for any individual foundation or endowment asset manager to take the time to consider it.

Underneath this, one can break down investment across multiple assets and strategies, with a blend of direct and indirect exposure, to high-tech, real estate, public equities, fixed income, government debt, private equity and so on.

It should be noted that BlueStar has worked with certain pioneering Federations such as Miami and Chicago to facilitate the first dedicated overweight in Israeli equities, via the NYSE-listed ISRA ETF tracking their BlueStar Israel Global Index. These were the early adopters, but disappointingly few have followed, despite an excellent product, low fees and strong performance. This seems to be a good example of the need to aggregate multiple approaches to the Israeli economy to achieve a critical mass of interest and investment.

BUILDING BLOCKS

In practice, we believe that the larger Federation endowments will work together to determine two or three preselected portfolios that others can invest in, reducing even further the cost and inefficiency for smaller endowments to participate.

In turn, by aggregating funds from across the whole community in this way, the platform carries enormous negotiating power with which to enter each part of the Israeli economy, delivering excellent financial returns to the Federations, as well as being able to measure for material impact on Israeli society.

It should be noted that there are specific provisions in American endowment management regulations, that allow for more flexible approaches to risk and return to be taken when there is a clear link between the underlying cause of the charity and the asset being invested in. Unquestionably Israel fits this stipulation.

In some asset classes which are well-established, it is a simple case of selecting the right allocation – for example the venture capital and private equity sectors, where there is ample support for our platform from the leading players, and a willingness to provide the data to allow decisions to be taken.

There is further motivation in that each individual fund manager has been largely unable to access investment from the endowment community, despite vast time and resource being expended, but there is recognition that the clearing-house that we propose is an immensely cost- and time-efficient way of pairing Diaspora investors and Israeli managers.

In other asset classes, there are unique opportunities to drive changes that the markets need, for example in public stocks, where governance is frequently imperfect, companies are closely controlled by a small number of families, and there are still multi-layered holding structures outside international norms. These and other factors are putting off major foreign institutions, suppressing valuations and reducing liquidity – the latter being a chronic problem outside the largest stocks.

This all has an unseen material effect on the average Israeli, as their pension funds are very heavily exposed to the Israeli public markets for obvious reasons, and many of these public companies are the biggest stiflers of the competition that would drive down the cost of living.

The adaption of a ‘broad, deep and complete’ benchmark for Israeli equities, such as the above-mentioned BlueStar index, can also serve to foster capital market development. When investors view – and allocate – to the full Israeli equity universe – inclusive of Israeli companies listed in Tel Aviv, New York, London, Australia, Singapore, Hong Kong and Toronto – Israel’s true weight in the global equity universe is fully-apparent. A similar global approach can often be taken in other asset classes, for example in venture capital, where Israelis play disproportionate roles in start-up hubs around the world, from Silicon Valley to New York to London to Berlin.

In other words, even investment in traditional asset classes, when done in the right way, turns out to be an impact investment. We have developed similar themes across every asset class, including some unique proposals for public-private partnership, using Israel Bonds as the logical partner to structure and carry out fundraising.

An example of this might be in reducing the cost of housing in Israel by making targeted investments in residential real estate projects. Returns on equity in most Israeli schemes are in double digits – far higher than a Federation endowment would expect to earn elsewhere.

The Federations could provide investment for a lower (but still secured and substantial) return and pass on the consequent reduction to first time buyers in a shared ownership model, which has had its successes in the UK and ensures that the stock is not simply sold on for a profit by the purchaser at the earliest opportunity. By developing this in partnership with the government, the Israel Lands Authority would also play its part by accepting a below-market price for the sites (plenty has been written elsewhere about the need to reform the ILA and encourage this type of approach).

ACHIEVING SCALE

We would like to see a commitment by the JFNA, led by a majority of its ten largest endowments (New York, Cleveland, San Francisco, Chicago, Boston, Montreal, Los Angeles, Baltimore, Detroit, NJ Metrowest), which together represent 70% of the total assets under management, to put 2% of assets into Israel by 2020. Assuming the other 30% come along under their leadership, this would create a $400m investment fund – sufficient scale to begin and make a material impact.

In turn, there is another $50-$70bn in other North American Jewish/pro-Israel foundations and endowments, who could be expected to follow their example and commit to 2% as a baseline. In many cases, this could be substantially higher – for example the Greater Miami Jewish Federation foundation, led by their exemplary outgoing CIO Alon Ozer, which holds some 10% of its funds in Israel-related assets.

We expect that with this $1.5bn of Jewish philanthropic endowment capital being deployed successfully and securely in Israel, high net worth investors with a Zionist motive would soon follow, and behind them would be institutions who simply take advantage of the scale model to gain access to the Israeli markets for the first time.

With that comes an opportunity for every American Jew to put a variety of Israeli assets into their 401k – with an average household net worth in the Jewish community of nearly $500,000, following the same 2% rule would deliver $15bn – TEN TIMES as much investment as the endowment pool alone, not to mention the reinforcement of the shared destiny of Diaspora and Israeli Jews, and the utter trouncing of the BDS movement.

Lest one believe that Israel cannot absorb or does not need this kind of financing, this would go only some way towards the closing of Israel’s well-reported infrastructure and socio-economic gaps, and providing the necessary liquidity and efficiency to a variety of markets. It would add, over a five year period, about 20% to net foreign direct investment.

This is a multiplier effect that the Federations would not only be able to claim credit for but financial reward for, as will be explained in our proposition below. It is important to place on record the enormous support that does exist within the Federation system for this kind of approach, which can be seen in the biennial JFNA Investment Institute progressively including Israel more and more seriously on its agenda. In particular we thank Steve Gross, Senior Director for Institutional Advancement, for years of guidance and leadership in this regard.

OUR PROPOSITION

We are grateful for the putative support of major Anglo-Jewish investors, who have generously offered to provide the substantial necessary capital to allow us to build and run the operational infrastructure for the platform on a non-profit basis, because they believe, as we do, that it will be the engine for a paradigm shift that is required in both Israel-Diaspora relations and in the Israeli economy.

However, they did so subject to one core stipulation: the JFNA and its largest Federations had to show leadership and bring together a critical mass of commitment to the project. Next week at the GA is the window for those leaders to make the initial steps to do so. They are the client; we are here to listen and shape things around their needs. But we must move beyond platitudes and into action.

Our standing offer to the JFNA is this: we propose a partnership with you and your constituent Federation endowments, to help them lead a new wave of investment in Israel, and reap the financial and impact benefits of doing so. Our team of Israel domain experts and experienced multi-asset managers, and an impressive array of advisors, are willing to offer their time and expertise on a success-only basis. In other words, we are rewarded only when Israel delivers a strong return to the Federations’ endowments.

We will share with the Federation endowments who launch this with us, the performance fees that are earned from assisting all non-profits. All of the net profits that our funders make here will similarly be put into their own foundation, and I am personally committed to do the same. We will also share with them 10% of our net profits from any private investor who states that they wish to support the JFNA. These Federations should be rewarded for showing leadership within the Jewish community.

We will contribute 10% of our net profits on all other clients to a donor-advised fund under the auspices of the JFNA, with a mission to provide ongoing education to the Diaspora about Israel’s economic situation and support the ongoing evaluation of Israel investment opportunities for its endowments and foundations.

CONCLUSION

These are not fanciful ideas – we have spoken with major investors and philanthropists, senior leaders within the Federation system, their financial advisors and consultants, some of the world’s most impressive asset managers, including the best in Israel, politicians and government officials, academic specialists in macro- and socio-economics, and so on, to both develop this concept and enlist their help to set it up and run it successfully.

The second part of this article, looking at the prospective non-financial impact to Diaspora Jews of their community’s foundations and endowments investing in Israel at scale, will be published in the coming days. Meanwhile, the author is chairing a panel at Limmud After Dark on the first night of the GA, 22^nd October, on this topic of Investing in shared destiny – economics and the Israel-Diaspora relationship.