The Little Growth Engine That Could

12/15/2009 12:00 pm EST

Focus: ETFS

Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Carl Delfeld, editor of Around the World with, says despite its tiny population Israel has emerged as a technological and entrepreneurial powerhouse.

Today, on a per-capita basis, Israel by far leads the world in research and technological creativity.

Between the years 1991 and 2000, Israel's annual venture-capital outlays, almost all private, rose nearly sixty-fold, from $58 million to $3.3 billion. From 100 venture-capitalized start-ups in 1991, Israel's venture funds launched some 800 companies in 2000. Israel's revenues in information technology rose from $1.6 billion in 1991 to $12.5 billion in 2000.

By 1999, Israel ranked second only to the United States in invested private equity capital as a share of GDP. With 70% of its growth attributable to high-tech ventures, by this measure Israel went in 20 years from last among all industrial countries to lead the world.

During the first five years of the 21st century, venture-capital outlays in Israel rivaled venture-capital outlays in all of the US outside California, long the world's paramount source of entrepreneurial activity in high technology.

In 2006, Israel's nearly 80 active venture funds raised $1.62 billion compared to $1.2 billion in 2005. The US was the only country that raised more venture capital in 2006 than Israel, but in contrast, Israeli investments were at an earlier stage in their start-up development, making eventual returns higher.

Although much of Israel's capital comes from the hugely greater American venture industry, Israeli companies are rapidly increasing their share. A 2008 survey of the world's venture capitalists by Deloitte & Touche showed that in six key fields—telecom, microchips, software, biopharmaceuticals, medical devices, and clean energy—Israel ranked second only to the US in technological innovation. Germany, ten times larger, roughly tied Israel.

Adjusted for its population, Israel ranked massively ahead of all other countries—including the US.

Israel has become a global center of microchip, telecom, optics, software, biotech, and medical-devices research, the country's development and entrepreneurship rivaled only by its partners in Silicon Valley.

As one prominent US engineer put it, "When I became VP of business development for ROW (rest of the world), it was obvious that Israel is now the capital of the rest of the world."

In addition, Israel may graduate to developed status as early as the first half of next year.

Finally, on a valuation basis Israel’s market trades a bit over 15x 2009 earnings relative to the emerging markets index at 17x and the Standard & Poor’s 500 at 18x.

iShares MSCI Israel’s (NYSEArca: EIS) largest holding by far is Teva Pharmaceutical Industries (Nasdaq: TEVA)—a leader in pharma on the side of generics. You may wish to get comfortable with Teva before pulling the trigger on EIS.

Of course, due to its geography, [Israel] has a fair degree of political risk. I suggest blending in EIS into a balanced emerging markets portfolio and using an 8% trailing stop loss.

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