Japanese Small-Cap Shares Come to Life

NEW YORK (TheStreet) -- Japan has been on the outs as an investment destination for two decades. But there has been a shift in politics that may favor small-company shares.

Japan's problems include a government debt load that's about twice the size of the country's gross domestic product. Last week, Japan held an election that had a historic outcome. After more than 50 years of control by the Liberal Democratic Party (LDP), the election was won by the Democratic Party of Japan (DPJ). The DPJ is more conservative, in that it wants smaller government, though it's looking to institute a higher minimum wage and improve benefits for workers.

Additionally, the DPJ wants to enact policy that spurs spending at home, which stands to favor smaller companies. In Japan, the bigger companies that dominate the iShares MSCI Japan Index Fund(EWJ) are exporters. If the DPJ can be successful, small-cap stocks stand to outperform as they better capture the story on the ground in Japan.

The iShares MSCI Japan Small Cap(SCJ), the SPDR Russell/Nomura Small Cap Japan ETF(JSC) and the WisdomTree Japan Small Cap Dividend Fund(DFJ) offer easy access if the theme plays out and small caps outperform. Small companies, as measured by exchange traded funds, have beaten the benchmark Nikkei 225 Index.

The sector make-ups of all three ETFs are remarkably similar. Industrials have the largest weighting, in the mid-20s, followed by discretionary, at about 20%, and all three have a mid- to low-teen weighting to materials. The biggest difference at the sector level is that the iShares fund allocates 18% to financials. Interestingly, the iShares funds have lagged behind the other two. Despite similarities at the sector level, the respective top-10 holdings have only two names in common between the iShares and SPDR funds.