In the past few weeks, and more so in the past few days, a lively discussion is developing over large overseas investments by Israelis. The sums mentioned by the press vary, not surprisingly, depending on the source being quoted. Overseas cash transfers are legal under the liberalization laws instituted four years ago, so the official figures will ultimately appear in the Bank of Israel¿s reports.

More important is the question of just who is investing abroad. There are two groups of investors in this arena: institutional investors, such as insurance companies and provident funds; and private investors ¿ wealthy established households. Although mutual funds handle private investors¿ money, they are included in the institutional category.

Among the institutional investors there is no doubt that the insurance companies have lately been investing higher sums abroad than the provident funds. This is probably because supervision of the insurance industry is more liberal than restrictions governing provident funds.

There are also two main groups among private investors: one that operates via agents and local financial institutions such as Israeli mutual funds and banks, and another whose funds are managed via foreign organizations that operate in Israel or that have representation here.

In the final analysis there is no doubt that there has been a considerable rise in overall investments abroad, with an upsurge just recently. What has caused this sudden increase? It could be attributed to the security situation, though most analysts point to the sharp drop in interest rates last December that sparked the depreciation of the shekel, as the immediate cause. The latter explanation seems more logical because the security situation has been bad for some time and the big wave of investments began just recently.

Both these reasons are circumstantial, however, and do not address the main issue ¿ why is there a tendency to invest abroad? In this context, the security situation could provide a partial answer ¿ Israel has always been a dangerous environment from the investors¿ point of view.

It is also likely that the primary explanation stems from the rational need to build a more diversified investment portfolio. Even in countries with no security risk, such as Switzerland, every professionally constructed portfolio has a large component of foreign investments. This is all the more true among institutional investors. It is therefore easy to justify the flow of investments overseas for professional reasons.

The effect of the security situation in Israel will only be discernable when we reach the stage at which the foreign component in the Israeli public¿s financial assets portfolio equals that in other small, more developed and more open economies.

Alternatively, we could try a hypothetical exercise. Let¿s suppose that tomorrow the proportion of overall investments abroad reaches an acceptable level for small countries like Israel; let¿s also suppose that tomorrow the security situation calms down, so that it is no longer a motivating factor; and let¿s say that the international markets continue to be vague and lacking in any clear direction, just as they are now. Based on these assumptions, how could we expect investors to behave?

The answer is that investors, chiefly institutional ones, would continue to increase the foreign investment component of their portfolios without any connection to political, security, economic or financial assessments. In fact, they would be doing it for lack of any other option.

The driving force behind this step is the basic fact in the life of the local investor: there is no capital market in Israel. There is no bourse with a serious turnover, there are no sophisticated financial instruments, and there aren¿t even enough simple ones. There are, however, an abundance of restrictive laws, suffocating supervision and technical and practical restrictions of every sort.

In what can insurance company managers and their mutual fund counterparts invest the large sums they have amassed? If they look to the local market they will quickly discover the iron rule of the prison on Ahad Ha¿am St: limited trade volumes mean that large institutional investors will sometimes be able to buy but will almost never be able to sell.

Insurance companies and mutual finds cannot invest in a broad variety of instruments ¿ particularly in solid instruments that are supposed to be traded on money markets and bond markets ¿ because there are none on the local landscape. It goes without saying that they cannot put together a properly diversified shares portfolio because whole branches of a developed economy do not exist in Israel, so the shares of companies active in such industries are not traded on the local market. Oil, mines, computerization, aviation and automotives top the long list.

More sophisticated investment strategies and their special instruments, such as hedge funds, are unheard of. They don¿t exist because the market does not facilitate their establishment by Israeli fund managers.

The law also drastically limits the ability of Israeli financial institutions to deal in areas that their foreign counterparts view as their daily bread, portfolio management, for example. Over the years Israeli banks have been hiding behind false profits gained from credit activity in the local market. They pretended that the total absence of professional client asset management was a marginal defect in the overall business structure.

They now understand that they will have to compete with foreign financial institutions that are much more sophisticated and experienced. This while bound hand and foot by the legal system and state supervision. With such a state of affairs, how can their customers be expected to remain faithful to them?

There are two possible scenarios regarding the future of investments in Israel: rapid and comprehensive reforms in the capital market, including the pension system, which will create a new and attractive reality for all types of investors; or the continued transfer of the public¿s money overseas, with the rate of transfer increasing or decreasing in keeping with short term developments.

Considering the time that has been wasted through inactivity and the dismal state of legislation, only the second scenario seems realistic.