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Japan's Rising ETF Plays

Anyone with, ahem, a yen for investing in Japan has dealt with limited choices when it comes to exchange-traded funds. The iShares MSCI Japan Index Fund (EWJ) and the S&P/Topix 150 Fund (ITF) are almost identical.

Toyota (TM) represents the largest holding in each ETF, followed by several bank stocks, with Honda Motor (HMC) mixed in too. It should be no surprise that the two have a very tight correlation, 0.968. Both funds have a beta greater than 1.4, compared with the S&P 500 at 1.0. Neither has much of a yield -- EWJ yields 0.44%, and ITF yields 0.32%.

While Japan is obviously a popular investment destination, I have never been a fan. A roadblock for me is that after years of interest rates at zero percent, the economy still is not quite healthy. I would rather have a clearer visibility for growth that most other Asian markets offer.

So before looking into the latest ETF offerings, be sure to ask yourself if Japan even belongs in your portfolio. And if you're still gung-ho, you're in luck. In the last few months there have been several new ETFs launched, offering different exposure to Japan.

Wisdom Tree Branches Out

Wisdom Tree came out in June with three Japan funds: WisdomTree Japan Total Dividend Index Fund (DXJ), WisdomTree Japan High-Yielding Equity Fund (DNL) and the WisdomTree Japan SmallCap Dividend Index Fund (DFJ).

The first two have a few things in common with the iShares funds. Toyota is the largest holding in each, but the sector composition is much different. Both EWJ and ITF are heaviest in the financial sector, but both DXJ and DNL put the consumer cyclical sector on top, followed by the industrial sector. These changes in sector makeup reduce the correlation to EWJ dramatically. Both DXJ and DNL correlate at only 0.74 to EWJ. The relevance of this is that given that all these funds invest in the same country, WisdomTree's two large-cap funds are not simply me-too products.

The yields are not that high, though, and this is a function of Japan's not being a high-yielding market. DXJ yields 1.52%, and DNL yields 1.97%.

The Four Big-Cap Japan ETFs
WisdomTree Japan High-Yielding Equity Fund proves the best performer thus far
Source: BigCharts

The above chart of all four big-cap Japan ETFs shows that in the short time since the WisdomTree funds listed, it's the highest-yielding DNL that has proved the best performer. This again brings up a question I raised in a column last week about WisdomTree funds: If dividends are what the firm believes drives outperformance, then that should mean that the higher-yielding DNL, which is a subset of DXJ, should always outperform the lower-yielding version. As I mentioned before, there are not enough data to support this just yet -- this is merely a theory of mine.

As a small-cap fund, the WisdomTree Japan SmallCap is a first for ETFs. This fund delivers on differentiation as well. The correlation to EWJ is 0.61, and industrials and consumer cyclicals are the two biggest sectors; it yields 1.62% and offers access to a part of the market that has not been easy to reach for most U.S.-based investors.
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DXJ $41.22 -0.17%
DNL $46.47 -1.49%
JSC $52.85 -0.92%
JPP $43.62 -1.34%
DFJ $54.91 -0.60%


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