Israeli Hedge Funds Lag Behind Benchmark Index for Second Year

Equity hedge funds in Israel are once again underperforming the Tel Aviv 125 index, a trend that has become a recurring challenge for active management. As of the end of the year's third quarter, these funds have delivered an average net return of approximately 9%, falling short of the Tel Aviv 125 index's 11% gain. This follows a pattern seen earlier in the year, where the funds initially outperformed the index in the first half before losing their advantage.

The comparison to a passive index like the Tel Aviv 125, which can be accessed through low-cost ETFs, highlights the difficulty for actively managed hedge funds to justify their higher fees and complex structures. Historically, this underperformance has been observed even in strong market years, with many funds struggling to generate alpha. For instance, in 2025, prominent equity hedge funds averaged a 41% return, significantly less than the Tel Aviv 125's 51% increase.

The market's internal dynamics in the third quarter contributed to this divergence. While the Tel Aviv 125 saw a modest 1% rise, the index's components diverged significantly, with the Tel Aviv 35 index gaining 3.3% and the Tel Aviv 90 index falling by a similar margin. This split created different investment environments depending on a fund's exposure to large-cap stocks versus mid- and small-cap equities, technology, real estate, or renewable energy.

Hedge funds' strategies, which often include holding cash, short selling, and purchasing hedges, can be detrimental in a gradually rising market, as these protective measures incur costs. Furthermore, poor stock selection in even a few positions can negate gains from successful ones. The wide dispersion in performance among hedge funds, with some like "Chazakim Long" returning 17% and others like "Alpha Value" losing 7%, underscores the diverse nature of products operating under the "hedge fund" umbrella.

Globally, a similar trend is observed, with only 27% of large US active funds outperforming their passive counterparts in a recent year, and even fewer succeeding over a decade. The article notes that while professional management can add value, identifying consistently successful managers beforehand is extremely difficult. High management fees, and sometimes performance fees, further erode the net returns for investors, making a return equivalent to the index less attractive on a cost-benefit basis. Additionally, hedge funds may have liquidity constraints and periods where accessing funds is difficult.

The Israeli market faces a particular weakness in transparency, lacking a comprehensive public database for comparing hedge funds' assets, exposures, volatility, and returns. Reporting standards differ from mutual funds, and the average return calculation can be skewed by the weighting of funds based on assets under management. Even in the bond market, the Tel Bond 60 index has outperformed the average return of nine prominent bond hedge funds this year, though the funds had previously outperformed the index in 2025.