The world of hedge funds, once considered an exclusive investment vehicle for high-net-worth individuals (“qualified investors”) and institutional bodies, has undergone a mini-revolution in Israel. A reform initiated by the Israel Securities Authority (ISA) approximately two and a half years ago allowed for the establishment of “Hedge Funds in Trust”, a product that combines the sophisticated strategies of hedge funds (such as Long-Short) under the transparent and accessible structure of traditional mutual funds. This new industry currently manages about 3.5 billion NIS, and its strong returns (the top performer posted a 58% gain year-to-date) are fueling its growing popularity.

The Strategy: Hedging Risk and Exploiting Market Distortions

Financial hedging (Hedge) is an investment strategy aimed at neutralizing or minimizing potential losses by setting clear boundaries for risk. These funds operate using techniques more sophisticated than traditional mutual funds:

Long-Short: The central technique involves trading pairs of assets, where the fund buys assets considered undervalued (a ‘Long’ position) and sells overvalued assets short. The goal is to profit from the convergence of prices between the assets, making the manager indifferent to the general market direction.

Multi-Strategy: Many funds employ several strategies simultaneously—such as Long-Short across different sectors or markets, or exploiting opportunities by taking positions contrary to prevailing market trends.

The objective of hedging is to achieve a low correlation with the stock market, thereby smoothing out the overall portfolio volatility for the investor.

Structural Advantages of “Funds in Trust”

The ISA’s reform created a product more attractive to the general public, providing several significant advantages over the traditional (private) hedge funds:

Liquidity and Transparency: While private hedge funds operate under secrecy and generally allow redemptions only once per quarter, the Trust Funds are committed to high transparency (publishing prospectuses and periodic reports) and generally allow redemptions once a month. Furthermore, they lack mechanisms like “Gate” or “Lock Up” that prevent withdrawals during times of economic stress.

Tax Deferral: In the Trust Funds model, capital gains tax is paid only upon realization (when the investor sells the units). This tax deferral advantage is extremely significant over long investment horizons, amplifying the effect of compounding interest. In contrast, investors in private hedge funds must pay tax on accrued profits annually, even if the investment has not been realized.

Low Barrier to Entry: The product is offered to the general public without a minimum investment amount (unlike the million-shekel-plus threshold for private funds).

The Cost and the Regulatory Threat

Alongside the advantages, it is important to recognize the costs and risks:

High Fees: The Trust Funds generally charge fixed management fees of 1% to 1.5% (similar to active equity funds), and the most significant cost is the success fee of approximately 20% of the profits. This fee structure, intended to attract sophisticated managers, makes them more expensive than passive mutual funds.

Leverage Risk: Hedge funds often use financial leverage, which increases the potential return but also elevates the level of risk, which may not align with every investor’s risk appetite.

The Political Threat (Stalled Regulation): The greatest threat to the industry’s continued growth is regulatory. The funds were initially launched under a temporary provision that required finalization through primary Knesset legislation. Due to political changes, the legislation has been stalled, and consequently, dozens of new hedge funds that filed prospectuses are “stuck in the regulatory pipeline” awaiting final approval. Although the ISA extended the temporary provision, there is concern that failure to pass the permanent law soon could halt the industry’s future expansion.