IBI's Fee Hike Triggers Massive 5 Billion Shekel Outflow From Israeli Bank ETFs

In June, Israel's mutual fund market showed a positive net inflow of about 2.8 billion shekels, totaling 36.6 billion shekels since the start of the year. However, a significant outflow of 4.9 billion shekels occurred specifically from bank exchange-traded funds (ETFs) managed by banks, marking an unusual event in the passive investment sector.

This outflow coincided with a sharp 6% drop in the banking stock index, but market insiders attribute the sell-off primarily to IBI Investment House's announcement that it would begin charging trustee fees to institutional investors managing public savings. Previously, IBI absorbed these costs, but now it is passing them on, prompting institutional investors to withdraw funds and move them elsewhere. Although the fee increase was minimal at 0.008%, the large volume of assets under management (around 15 billion shekels in the "Israel Banks Index" ETF) made the annual cost to IBI significant, estimated at 1.2 to 1.5 million shekels.

IBI inherited this ETF from its acquisition of Psagot Investment House funds about 18 months ago. This move follows similar actions by other investment houses like Phoenix, Meitav, and Harel, which shifted trustee fees to institutional investors two years ago, leading to losses in these funds and causing some investors to exit.

The underlying regulatory context complicates the situation: Bank of Israel limits institutional investors to holding no more than 7.5% directly in bank shares. To circumvent this, institutions buy bank ETFs, but the Capital Market Authority forbids passing ETF costs directly to the public, making these funds unprofitable for institutions. Consequently, institutions are now shifting their exposure from ETFs to derivatives such as swaps, which carry significantly higher costs, estimated at 0.5% annually, about 50 times the ETF fee.

Market sources estimate that if the 5 billion shekels exit from ETFs to derivatives, the public could face an additional 25 to 75 million shekels in annual fees. Moreover, derivatives expose investors to greater risks, including counterparty risk. Regulators maintain their positions: Bank of Israel sees the ownership limits as necessary to prevent excessive control by institutions over banks, with no current plans to change them, while the Capital Market Authority expects institutions to act in the best interest of savers despite the fee shifts.

This regulatory and market dynamic has led to a complex situation where institutional investors avoid direct bank shares due to limits, ETFs become unprofitable due to fee rules, and derivatives become the costly alternative, ultimately burdening the public with higher costs and risks.