Israel, under threat of war from its neighbors since being founded in 1948, produced better risk- adjusted returns than all other developed stock markets in the past decade as the technology-driven economy attracted global investors.

The BLOOMBERG RISKLESS RETURN RANKING shows the Tel Aviv TA-25 Index (TA-25) returned 7.6 percent in the 10 years ended yesterday, after adjusting for volatility, the highest among 24 developed-nation benchmark indexes. Israel beat Hong Kong’s Hang Seng Index (HSI), the next-best market with a risk-adjusted gain of 6.7 percent, and Norway, which had the highest total return.

Israel outperformed as it fought a monthlong battle against Hezbollah in 2006, was involved in a similar conflict with Hamas two years later and is now threatened by Iran’s nuclear program. International investors including Warren Buffett bought local companies and the economy, steered by Bank of Israel Governor Stanley Fischer, grew more than twice as fast as the U.S. last year. Israel’s stocks may extend gains as Apple Inc. (AAPL) and International Business Machines Corp. (IBM) acquire the country’s technology startups.

“Israel is an exciting place to invest,” Michael Steinhardt, the former hedge fund manager who produced returns averaging 24 percent a year over almost three decades until he retired in 1995, said in a telephone interview from Fisher Island, Florida. “The country is surrounded by enemies, it’s always on the edge of extinction, but it expands and prospers.”

Beating Norway

The Israeli gauge returned 161 percent including dividends over the last decade, the third-best performance among developed markets after Norway’s OBX Index and the Hang Seng.

While Oslo’s index produced the highest return, its volatility was 35 percent greater than that of the TA-25. Statoil ASA (STL), the world’s seventh-largest oil exporter, comprises more than 25 percent of the gauge, making the market susceptible to changes in oil prices. Only one developed-market benchmark gauge, Denmark’s OMX Copenhagen 20 index, gives a bigger weight to a single company.

The TA-25’s biggest members are Bank Leumi Le-Israel Ltd. (LUMI) and Teva Pharmaceutical Industries Ltd. (TEVA), each with an 11 percent share. The biggest weighting in the Standard & Poor’s 500 Index (SPX), the U.S. benchmark, is Apple Inc. with 3.8 percent.

Fischer’s Role

The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price-swing variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period of time, increasing the potential for unexpected losses compared with a security whose price moves at a steady rate.

Bank of Israel’s Fischer, a former thesis adviser to Ben S. Bernanke, helped steer the economy back to growth after the worst global recession since World War II. Fischer, who is serving his second term as governor, began buying foreign currency in 2008 after the shekel reached a 12-year high. That more than doubled the central bank’s reserves in an effort to help exports, which are equal to 40 percent of gross domestic product.

Israel’s economy probably expanded 4.8 percent in 2011, compared with 1.8 percent growth in the U.S., according to the International Monetary Fund. That follows five years of average annual growth of 4.2 percent, boosted by foreign investment in local companies.

Outpacing G-10

Private consumption expanded at the fastest pace in at least five years in 2010, climbing 10.2 percent, according to Central Bureau of Statistics data. The growth attracted Hennes & Mauritz AB (HMB), Europe’s second-largest clothing retailer, which has opened eight local stores since March 2010.

The country’s gross domestic product will grow 3.2 percent in 2012, according to Finance Ministry projections. That’s almost three times the 1.2 percent average for the Group of 10 countries and faster than the 2.2 percent expansion in Norway, according to data compiled by Bloomberg.

Israeli stocks benefited in the past from investor interest in emerging markets, and may underperform when the global economy slows, said Michael Shaoul, chairman of New York-based Marketfield Asset Management, which manages $1.3 billion.

“The TA-25 was a big beneficiary of EM-related flows over the last decade,” said Shaoul, whose Marketfield Fund beat 97 percent of its peers in 2011. “It doesn’t matter how MSCI categorizes Israel, it still trades with the emerging-market complex.”

Market Upgrade

The MSCI Emerging Markets Index (MXEF) gained 189 percent in the 10 years through 2011, not including dividends, about 10 times the MSCI World Index of developed countries’ gain, data compiled by Bloomberg show. Israel was added to MSCI Inc.’s developed market index in May 2010.

After that change, investors pulled a net $795 million from Tel Aviv shares by the end of the year, while in 2009 they added $1.7 billion. All investors tracking the MSCI index had to rebalance their portfolios as Israel was removed from the emerging-markets gauges.

This year, the TA-25 had its best start of a year since 1997, with a 3.1 percent rally in January. The measure gained 0.3 percent at 9:57 a.m. in Tel Aviv. IBM said on Jan. 31 that it’s acquiring Worklight Inc., the closely held provider of a mobile application platform for smartphones and tablets whose research and development is based in Shefayim, Israel, as the world’s biggest computer-services provider looks to enhance its mobile-service offerings.

IBM, Apple

The announcement came less than three weeks after Apple, the world’s biggest smartphone vendor, acquired Anobit Technologies Ltd., an Israeli company that makes flash-memory drive parts for the iPhone and iPad. Apple paid about $390 million, according to two Anobit shareholders, who spoke on condition of anonymity.

Buffett, 81, who in 2006 bought Israeli tool manufacturer Iscar Metalworking Cos. for $4 billion, and Steinhardt, 71, credited the success of the country’s companies to technological innovation. For a small nation, Israel has contributed a disproportionately high number of Nasdaq companies, Steinhardt said.

Steinhardt opened New York-based Steinhardt Management Co. in 1967 and is now chairman of WisdomTree Investments Inc., a New York-based asset-management firm that offers exchange-traded funds. Buffett, through four decades of takeovers and stock picks, built Berkshire Hathaway Inc. (BRK/B) from a failing textile mill into a $195 billion provider of insurance, energy and consumer goods, and accumulated the world’s third-biggest personal fortune.

‘Looking for Brains’

“If you go to the Middle East and you’re looking for oil, skip” Israel, Buffett said in 2010. “If you’re going looking for brains, just stop at Israel. You don’t have to go anyplace else.”

Israel’s stock market outperformed even as the country was under constant threats of violence. The Hezbollah movement, a Shiite Muslim political party that is considered a terrorist organization by Israel and the U.S., fired rockets into the country’s north in the July-August 2006 Second Lebanon War. Israel launched Operation Cast Lead, a three-week offensive against the Hamas movement, which controls the Gaza strip, in December 2008.

Iranian President Mahmoud Ahmadinejad said Israel should be wiped off the map. Israeli leaders have been warning publicly that time is running out to stop Iran from developing nuclear weapons at a time when the country faces security threats as the so-called Arab Spring creates turmoil in its Middle Eastern neighbors.

‘Military Action’

“It will take a lot more than a simple military action to keep the stock exchange from working,” Gilad Alper, an analyst at Excellence Nessuah Investment House Ltd. in Tel Aviv, said by telephone. “The last full-scale war that we had here that involved huge parts of the economy was in 1973. Since then, everything has been relatively small.”

Israeli companies have benefited from diverse geographic revenue. Teva, the world’s largest maker of generic drugs, and Israel Chemicals Ltd. (ICL), the harvester of chemicals from the Dead Sea, comprise more than 20 percent of the TA-25 and get less than 6 percent of their revenue from Israel. Exports make up about 40 percent of Israel’s economy and the country’s high- technology industry accounts for 47 percent of manufactured overseas shipments, according to the central bureau of statistics.

‘Attractive’ Dividends

“There are a lot of Israeli companies with a global footprint, and many are global leaders,” Steven Schoenfeld, the founder of New York-based BlueStar Global Investors LLC, a financial information and research company, said by telephone.

Israeli companies also returned more money to investors than those in other developed markets. The dividend yield of the TA-25 Index is 3.53 percent, compared with a 2.66 percent average for companies on the MSCI World Index of developed markets. It’s boosted by companies such as Cellcom Israel Ltd. (CEL) and Hot Telecommunication System, with 14 percent and 12 percent yields, respectively.

“The dividend yield of companies on the TA-25 Index is very attractive,” said Jacob de Tusch-Lec, a London-based money manager at Artemis Investment Management LLP in London, which oversees $17 billion.

‘Safe Model’

Standard & Poor’s raised Israel’s credit rating for the first time in four years in September, lifting the country to A+, in line with Chile and Slovakia. S&P cited local economic growth for the upgrade as well as expected production of natural gas by the middle of the decade that will further increase the economy’s efficiency and strengthen its fiscal and external positions.

“Israel has very well-capitalized banks and an economy that is well-balanced with the high degree of high tech,” in addition to “one of the best central bankers in the world,” Artemis’s de Tusch-Lec said. “This is not an economy that was built on cheap leverage,” he said. “This is a safe business model.”

To contact the reporter on this story: Tal Barak Harif in New York at tbarak@bloomberg.net

To contact the editors responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net; Emma O’Brien at eobrien6@bloomberg.net