Pluses and Minuses of State of Israel’s Bonds

Investors have always wanted to make money, but in recent years more and more people seem interested in doing good while doing well. That’s been the impetus behind dozens of “socially responsible” mutual funds, which seek to invest in ways that advance certain social aims.

Now, as U.S. government financial support of Israel is increasingly challenged, the Development Corp. of Israel is hoping that more American Jews pick up the social investment gauntlet and buy State of Israel bonds.

Since 1951, when the program started, Israel has raised $12 billion in this way from investors in North and South America and Europe. Past offerings have financed Israel’s infrastructure--roads, power plants and so forth.

But since 1990, proceeds have gone to providing jobs and housing for Russian and Ethiopian immigrants--an aim that is controversial in some quarters but that many American Jews support, said Harold Samuels, executive director of the State of Israel Bonds office in Los Angeles.

Israel bonds are an interesting hybrid investment. Individuals--as opposed to pension and employee benefit plans--buy about two-thirds of the bonds sold. Although an occasional Gentile has purchased a bond or two, the bulk are sold to American Jews who want to support their ancestral homeland.

What makes Israel bonds noteworthy?

Unlike the bonds of many foreign nations, they are sold directly through Israeli government offices in the United States, which eliminates brokerage fees. There are about 70 such offices throughout the country, mostly in major cities such as Los Angeles.

The bonds pay principal and interest in U.S. dollars, which eliminates currency fluctuation risks that afflict most international investments.

In these ways, buying Israel bonds is similar to buying Treasury securities direct from the Federal Reserve. But the similarity ends there.

The biggest difference is that Israel bonds are guaranteed by the Israeli government, not the U.S. government.

And although Israel has never defaulted on any interest or principal, it is less credit-worthy than the United States.

Also, the price of U.S. government bonds is set at auction. Treasury officials first announce the coupon rate and then, depending on prevailing interest rates on the day of sale, the bonds will sell at a premium or a discount to face value. The interest rate remains constant, so those who buy and hold Treasuries enjoy a set yield to maturity. They’re liquid too; an active secondary market for Treasuries means that anyone can sell at any time.

Not so with State of Israel bonds. Anyone who wants to sell before Israel bonds mature can only sell them back to the Israeli government, and such sales are allowed only on certain bonds under certain circumstances.

For example, if the bonds were purchased for an employee retirement plan, they can be redeemed when the retirement plan is terminated. If purchased by individuals, certain bonds can be cashed only after 5 to 7 years. Others can only be sold early if the original owner dies.

On the other hand, although the interest rate is set at the time of purchase, it can go up if the U.S. prime rate rises above certain thresholds. That reduces some of the interest rate risk that investors take on when they buy other long-term bonds.

Still, interest rates on Israel bonds are not particularly generous. Israel’s Individual Variable Rate Issue Bonds, which can be bought in denominations of $2,000 (for IRA accounts) to $5,000, pay 5% plus half the difference between that and the prime rate, with a guaranteed minimum of 5%. These bonds now pay 5.75%.

Another Israel bond, requiring a minimum investment of $25,000, pays at least 7.5%. If prime rises above 7.5%, the rate will rise to 7.5% plus half the difference between that and prime. So if prime rose to 14.5%, the bond would pay 11%.

The dollar-denomination and variable interest rates make these bonds worth thinking about for those who believe in the cause. But at least some investment specialists maintain that mixing investing with social aims is usually foolhardy.

Investors need to consider whether both they and their cause can do better when the issues are handled separately, said A. Michael Lipper, president of Lipper Analytical Services in New York.

“The combination of trying to make money while giving it away normally produces less satisfaction on a total basis than doing each one separately,” he said. “You should use your money to produce the highest prudent return and then give the profits away as you choose.”