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By Bloomberg

Jerry Cutiesteanu said it came as no surprise when the Bank of Israel last week warned that risk in the country's corporate bond market may be underpriced. He had already begun cutting his holdings.

"Risk is absolutely not priced in," the senior investment manager, who helps oversee about 17 billion shekels ($4.6 billion) at Israel Brokerage & Investments Ltd., which has one of the country's top five performing fixed-income funds, said by phone on Sept. 29 from Tel Aviv. "The interest rate is at an all-time low. The corporate bond market, like government bonds and stocks, is rising with the increasing inflow of money."

The Tel Aviv Bond 40 Index yesterday closed near an all- time high set on Aug. 31, as investors chased returns after Israel's central bank on Aug. 25 cut its benchmark lending rate to the lowest on record. The index was little changed at 309.45 at 1:35 p.m. in Tel Aviv. Bond spreads remain low, which "may indicate the underpricing of risk," the Bank of Israel said when it held the rate last week.

Cuts in borrowing costs, intended to revive an economy that the government predicts will register its slowest growth in five years, have tempted about 20 percent more corporate issuers to sell bonds in the country this year than in all of 2013. The extra supply has done little to cool prices, prompting investors including Tel Aviv-based Epsilon Investment House Ltd. and Petach Tikva-based Excellence Provident Funds to limit exposure to the securities.

Gaza War

As investors scour the market for higher returns, the spread between the Tel Aviv Bond 60 Index and government debt this year declined to the narrowest since at least 2011, according to Bank of Israel data. The central bank, led by Governor Karnit Flug, in August unexpectedly cut its benchmark interest rate for a second straight month in an attempt to boost an economy hit by slowing exports and the seven-week war in Gaza.

"I'm much more selective in the corporate debt market as some investments are too expensive and not worth the risk," Idan Azoulay, chief investment manager at Epsilon, which manages assets of about 4 billion shekels, said by phone Sept. 29. Azoulay is buying mainly dividend-paying stocks, he said.

The TA-25 Index, Israel's benchmark equities gauge, climbed to a record this week. Tel Aviv's bourse remains undervalued even after rising almost 10 percent this year, Ori Greenfeld, chief economist at Psagot Investment House Ltd., said by phone Sept. 28. Stocks are the most attractive asset class, especially with bond yields so low, he said.

Cheap credit has fueled more and bigger debt sales. Companies including Israel's largest banks raised 43.9 billion shekels this year through Sept. 18, according to Tel-Aviv Stock Exchange data, compared with 36.7 billion shekels in all of 2013. Bank Hapoalim B.M. sold 3.05 billion shekels in bonds on Sept. 15, a record amount for Israel.

Ratio Demand

The low yields may persist through this year and 2015 after the inflation rate dropped to zero and as economic growth slows, according to Shuki Arditi, a bond trader at Tel Aviv-based Leader Capital Markets Ltd. That means continued demand for corporate debt, he said.

"There's still appetite in the market," Arditi said by phone yesterday. "Look no further than the healthy demand for recent debt offerings."

A Ratio Oil Exploration 1992 LP debt offering yesterday received institutional demand of 510 million shekels, double the amount offered, according to a Tel Aviv bourse filing. Meanwhile retail investors have plowed money into corporate bond mutual funds after rate cuts, according to Ronen Matmon, chief investment officer at Excellence Provident, which manages 21 billion shekels.

"The public has been pumping money into the corporate bond market via mutual funds, which has created an environment where spreads are too low for my liking," Matmon said by phone Sept. 29. "I'm not increasing exposure to the corporate bond market as this level of spreads do not justify investment."