Tokyo is the city where the Olympic Games 2020 is set to play out over the next fortnight and with the games now officially underway, ETF Stream has dissected the Japan ETFs available in the European market and selected one strategy to sit on top of the podium.

This is no easy task. The market boasts a wide variety of indices with household benchmarks such as the Nikkei 225 and TOPIX seen as ways to check the temperature of the Japanese economy while index provider giants including MSCI and FTSE Russell have muscled their way in and now offer a range of strategies from broad-based through to small caps and ESG.

Due to ballooning investor demand, issuers in Europe have launched ETFs offering exposure to the world’s third-largest economy at a rapid rate over the past decade.

The majority track the MSCI Japan index which is currently a basket of 272 large and mid-cap Japanese companies including household names such as Toyota, Sony and Mitsubishi.

It is a similar story for the FTSE Japan index which is tracked by the Vanguard FTSE Japan UCITS ETF (VJPU) and is a basket of 507 large and mid-cap stocks. Meanwhile, the Nikkei 225 includes the 225 most actively traded companies on the Tokyo Stock Exchange.

However, the latter falls down because it is price-weighted meaning a company’s size within the index is driven by its share price, not its market cap – similar to the Dow Jones Industrial Average.

This is an antiquated way of calculating an index – the Nikkei 225 was first calculated in 1950 – as it does not take into account the size of a company but instead, its trading price which could be viewed as an arbitrary measure.

Furthermore, the Bank of Japan’s decision to no longer purchase Nikkei 225 ETFs as part of its quantitative easing programme in March has impacted the performance. Since the BoJ made the announcement, the DWS Nikkei 225 UCITS ETF (XDJP) – the preferable of the Nikkei 225 ETFs – has fallen 5%, as at 22 July.

Tackling the Bank of Japan's ETF dilemma

There is also the Solactive Core Japan Large & Mid Cap index, which is available through the L&G Japan Equity UCITS ETF (LGJG), one small cap ETF and a host of ESG ETFs that have been launched in recent years.

However, it is tough to look past the largest ETF of the category, the iShares Core MSCI Japan IMI UCITS ETF (SJPA), which has collected $4.7bn assets under management (AUM) since launch in September 2009.

The reason why SJPA has clinched the gold medal is it offers exposure to the entire Japanese stock market including small caps at a cut price of just 0.15% which is competitive especially considering the average trading spreads are 0.13%, according to data from Bloomberg.

In the words of the late Jack Bogle: “Owning the stock market over the long term is a winner's game but attempting to beat the market is a loser's game.”

SJPA is a basket of 1,200 stocks that covers approximately 99% of the free float-adjusted market cap in Japan versus 85% for the MSCI Japan and as a result, provides investors with small cap exposure that they otherwise would not have.

With corporate governance reforms taking shape over the past decade under President Shinzo Abe, there has not been a better time to be a foreign investor in Japan, however, due diligence is always required when selecting the right ETF for portfolios, especially if investors want to see gold medal-like returns.

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