The security events of the last month, negative macroeconomic data, and estimates that the Israeli economy won't recover soon, have led foreign investors to sell Israeli bonds, mainly government bonds and Israel Electric Corporation bonds, cutting their Israeli exposure.

The big supply of bonds wasn't reflected in prices sharply dropping or yields rising in most of these bonds, due to demand from local institutional investors. Local institutional investors and foreign institutional investors conceive the Israeli risk differently. Israeli investors acquire bonds even when economic and political uncertainty is high, assuming that once calm is restored, bond prices will rise and generate capital gains.

The transfer of bonds from foreign investors to local investors isn't reflected in the prices of most bonds but is clearly discernable in certain series, mainly IEC bonds, which local investors are not eligible to acquire.

The trend can be illustrated by comparing the yield on IEC bonds, (-A) and the yield on Lehman Brothers (NYSE:LEH) bonds (A).

IEC bonds redeemable in 2006, which can be acquired by local investors, traded at 5.55% yield, very close to the yield at which the LB bonds trade, 5.6%. However, IEC bonds redeemable in 2009, which Israelis cannot acquire, traded at 7.35% yield, compared with 6.5% yield of LB bonds for a similar period.

The reason: Given demand by local investors, no price gaps were opened in IEC bonds that local investors can acquire, but a 1.25% yield gap was created in IEC bonds that Israelis can't acquire. In other words, foreigners sold these bonds, but lack of Israeli buyers and low foreign demand resulted in dropping prices and rising yields.

Demand for Israeli bonds traded overseas has greatly increased of late due to marked increase of private and institutional investment overseas. Israeli bonds overseas trade on attractive yields relative to alternative foreign currency investments in Israel. For instance, investing in New Gilboa dollar bonds carries much lower yield, less than 2%.