Rediscovering Japan through ETFs

After 30 years, is the country ready for a comeback?

Rob Isbitts

Kabukichō, Tokyo street with many signs

Japan, once the largest stock market in the world, is again providing ETF investors with motivation to take a closer look.

Optimism about some long-awaited changes in economic policy, a stable currency and attractive fundamentals have started to bring foreign investors back to the land of the rising sun.

The key now is whether this is merely a trading opportunity or a time to truly rediscover Japan as a core part of portfolios.

"Discovering Japan" was a 1979 song by British rock musician Graham Parker. It was not released as a single, but fans loved it anyway, and it became one of his most popular songs.

The Japanese stock market had its heyday not long after that song was released. And since 1991, it has just been trying to get back there.

Japan's Nikkei stock market index peaked in 1991 – as in, last century. Some 32 years later, it finally recaptured that high level.

Decades of slow economic growth, a large elderly population creating a strain on Japan’s social security system, and persistently low interest rates conspired to make Japan, once the largest stock market in the world, a complete afterthought.

Since 2013, the Bank of Japan (BoJ) has made a concerted effort to keep yields on 10-year Japanese government bonds within a 0.5% range either side of 0%, what is known as the BoJ’s yield curve control economic policy.

That was more acceptable to investors when global inflation was also near zero, but those days are gone. For some, that news is a game-changer that reopens Japan as an investable equity market, potentially ending decades of stagnation.

In a world equity market where “overvalued” seems to be the stock market’s middle name, there is an increasing tide of enthusiasm for Japanese equities. The country’s stock market generally offers investors a relatively low P/E ratio and lighter emphasis on technology stocks than many developed markets.

Japan’s greatest hits

The iShares Core MSCI Japan IMI UCITS ETF (SPJA) is Europe's largest Japan ETF having gathered $3.8bn assets under management (AUM) since launching in September 2009. With a total expense ratio (TER), SPJA tracks the MSCI Japan Investable Market index of 1,080 companies.

Meanwhile, the $122m WisdomTree Japan Equity UCITS ETF (DXJ) offers a different exposure to the Japanese equity market. Tracking the in-house WisdomTree Japan Hedged Equity UCITS index, DXJ is fundamentally weighted and employs a screening using the quality and momentum factors.

Finally, the $249m iShares MSCI Japan Small Cap UCITS ETF (ISJP) currently offers exposure to 845 small cap stocks in Japan via the MSCI Japan Small Cap index. ISJP has a slightly higher weight to the materials sector versus the broader benchmark but a smaller weight to financials and tech.

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