WHEN STOCK MARKET INVESTORS think of emerging markets, their attention focuses on South East Asia. But in 1943, the world's best performing market was Israel, which witnessed the culmination of a five year run which pushed the share index up by 750%.

Israel's economy was booming and domestic

investors were turning their attention to the stock market. Meanwhile, as foreign companies such as Siemens, Cable and Wireless, the French hotel group Accor and US computer giant Intel were rushing to set up operations in Israel, overseas investors began looking at investing in Israeli shares as well. "We think this is a tremendous time to invest in Israeli shares," declared Bob Mittelman of US investment bank Oscar Gruss, recently. "The buy opportunities are huge, and, with patience, current values could quadruple." The exchange which first began operating back in 1935 gradually evolved into the Tel Aviv Stock Exchange, or TASE, as it is widely known. The use of a computer call market enables stock exchange members to trade using the TASE computer, which means that there is no need for a trading floor.

There are four quoted indexes:

* General Index -- composed of all publicly quoted shares.

* Two Sided Index -- aggregate of the 100 leading Israeli companies.

* Maof Index -- 25 selected blue chip equities.

* Caram Index -- shares traded under the multilateral trading system.

A derivatives market has also been operating for the last 18 months and trading volumes have grown rapidly in that time. To date, derivatives are used for speculative purposes, rather than for hedging risks, and are used to venture the level of the Maof Index at a future point in time. At this stage, it is not possible to trade options on individual company shares.

A number of Israel's largest companies have also gone to the United States, in search of equity funding. In fact, with the exception of Canada, more Israeli shares are listed for trade in New York than shares of any other country. Currently, about 65 Israeli companies are listed in New York, with a combined market capitalization of over $8m.

The result has been a growing interest in Israeli companies from fund managers and investors. "Israel is a special opportunity," says Daniel Dunn of US investment bank Merrill Lynch. "Israeli shares are popular in New York where fund managers are looking for new emerging markets, and they perceive Israel as being a rather unique one because of the high concentration of scientific population there. The economy is also growing faster than many emerging markets."

The TASE is relatively open to overseas investors, who are able to trade individual company shares, convertibles, government and corporate bonds, or buy holdings in mutual funds. A number of funds are operated by Israel's large banks. However, with the increasing interest being shown in the market by both private and institutional investors around the world, several overseas Israeli share funds have been set up. These include the "First Israel Fund" and the UK based "The Israel Fund plc", which was launched in London last year with capital of $150m.

Foreign investors still account for only 2% of share holdings and the TASE continues to be dominated by Israel's major banks, which are estimated to control over 75% of the market. According to one analyst, overseas interest has mainly come from Jewish investors but this is expected to change over the next few years, as foreigners begin to play a greater role.

The TASE achieved further international recognition with its recent inclusion, in March of this year, in the authoritative Morgan Stanley Capital International's Emerging Market Index. Shares of 51 Israeli companies were selected for the index, which is updated on a quarterly basis. "By virtue of the fact that Israel is now included in the benchmark," says Mark Sladkus, publisher of the index, "a fund manager will have to take a position on investing in the country. I think it will cause people to invest more in Israeli stocks."

The period up until early last year saw a sustained period of rising prices on the TASE. This was underpinned by the country's rapidly improving economic position and the growth in corporate earnings. The peace accord with the Palestine Liberation Organisation provided a further boost to the market. In the post-PLO accord euphoria, expectations of a "peace dividend" ran ahead of itself. At this time, there was also a sharp increase in overseas interest in Israeli equities.

Even though the number of listed companies doubled between 1991 and 1994, demand continued to outstrip supply in this period. A recent report by merchant bank Goldman Sachs praised Israel's programme of capital market reforms but noted that by allowing provident (superannuation) funds to invest more money in equities, whilst stalling on its planned privatisation programme, the government helped create a disequilibrium between supply and demand. This artificially pushed up share prices.

After a five year bull run saw the TASE rise more than seven fold, the market turned in 1994. It is a popular myth that the market collapse was triggered by the combination of the Hebron massacre, when a lone Jewish gunman murdered a number of Palestinians at prayer, and the decision by the US Federal Reserve to start to raise US interest rates. The later event, of course, caused many of the world's equity and bond markets to turn bearish last year. Research has shown that the Hebron massacre had remarkably little impact on the TASE, whilst the market actually bucked the global trend and rose on the first two occasions when US interest rates were increased.

As a report by US bank Merrill Lynch concludes, the event that caused the market to turn in 1994 was the series of unfolding scandals involving share price manipulation and insider dealing. An investigation by the Israel Securities Authority led to the arrest of a number of prominent market participants. Many investors concluded that the market as a whole was probably rigged and returned to bank accounts as a safe haven for their money. As the market became bearish and started to slide, negative sentiment was reinforced by escalating inflation and the soaring domestic interest rates that this triggered, the downturn in corporate earnings, the faltering peace process and by the government's ultimately unsuccessful attempt to introduce a capital gains tax.

In 1994, the market slid by over 30% and continued to drift downwards at the start of this year. The TASE has picked up since than, buoyed by news of falling inflation and interest rate cuts. By late August, the index had broken through the psychologically important 200 barrier, showing impressive growth of almost 20%, in dollar terms, since the start of this year. Trading volumes are also showing an encouraging improvement, as buyers return to the market.

Analysts expect the TASE to be further boosted by privatisations, which may come to the fore over the next few years. Israeli economic commentator, David Rosenberg, sees Israel's plans for large scale privatisation, so far, as having been a story of missed opportunities. The government is now beginning to push ahead on the privatisation front and, late last year, it sold off stakes in two of Israel's largest companies. It intends to eventually sell off 140 of the 170 companies which were under state control. Experts estimate that these companies could add as much as $10bn to the market's capitalization, and increase of 25% in the size of the market.

If this is combined with much needed market reforms, then the TASE may start to improve its efficiency. A larger, more mature market may also be less prone to wild fluctuations -- today, investors are either all buying or all selling and that situation needs to change. Successful reforms, underpinned by projected GDP growth rates of 5-6% over the next few years, point towards a rosy future for TASE.