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Japan's Rising ETF Plays

Roger Nusbaum

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.

Two Adds From State Street

In the last couple of weeks, State Street Global came out with two Japan ETFs of its own, a large-cap and a small-cap fund that are based on indices from Russell/Nomura.

Because they are brand new, about the only thing to look at is the composition of the funds. The large-cap fund, the StreetTracks Russell/Nomura Prime Japan ETF(JPP), looks similar to the iShares large-cap funds. Toyota is the largest holding followed by a bunch of bank stocks with Honda Motor in the mix as well. Consumer discretionary, or consumer cyclicals, is the largest sector at 21% followed very closely by the financials at 20%. For now, there is no dividend information, but looking at the top 10, which accounts for 20% of the fund, I would expect the yield to be lower than those of the WisdomTree funds.

The other fund from State Street is the Russell/Nomura Small Cap Japan ETF(JSC). In comparing it with the WisdomTree small-cap fund, there is not a lot of stock overlap, which is normal when looking at different small-cap funds. The sector weights are similar -- both have the largest weighting in industrials at roughly 27%, followed by consumer cyclicals at close to 23%. From there it mixes up a little with tech having a 13% weight in JSC compared with only 4% in DFL. This gives JSC a little more of a growth bias. The fact that DFL is more value-oriented should be expected, as it is dividend-weighted.

For now, State Street's large-cap offering may not be much different, but the small-cap fund does seem like it could offer something different from what WisdomTree does.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider WisdomTree Japan Total Dividend Index Fund, WisdomTree Japan High-Yielding Equity Fund, WisdomTree Japan SmallCap Dividend Index Fund, streetTracks Russell/Nomura Prime Japan ETF and Russell/Nomura Small Cap Japan ETF to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.