Japan has perhaps surprisingly been overlooked when it comes to income, despite as what Adam Laird at Lyxor Asset Management describes as its current "compelling dividend story". To answer this apparent lack, the company has launched a new Japanese dividend ETF that will be listed in London and Paris and will track large Japanese companies based on the size and consistency of their dividend payments. ETF Stream caught up with Laird to discuss the new launch in detail.

Why launch a Japanese dividend fund now?

Yields have been rising, and this can offer some diversification to an existing dividend portfolio. Japan's dividend yield is well supported by earnings, strong balance sheets and strong cash positions.

What is the differentiator here for this fund?

We launched this ETF tracking the SG Japan Quality Income index - Lyxor is the only place to get access to the SG Quality Income ETFs. The strategy was created by Andrew Lapthorne, Extel Survey's number one rated quantitative analyst every year for the last nine.

Why should investors consider this fund?

In this low-income environment, there's a danger that income seekers are pushed towards risky companies to boost their dividends. But the yield trap can harm returns in the long run, if dividends are cut or prices are more likely to fall. The index is designed to not only provide a high yield now, but one that can be sustained over different economic cycles. It does this by focusing on high-quality companies, whose financial strength makes them more likely to sustain their dividend if markets fall, and grow it when they rise.

What type of investor will this fund appeal to?

This fund would suit an investor who wants to add some diversification to their income portfolio - looking at new geographies, but without taking on unnecessary risk. But remember that it's not just for investors who need to draw an income now - reinvesting dividends can lead to higher growth in the long run.

Can you explain more about the index these funds will follow and how they are constructed?

The basic idea is to identify higher quality well run companies with higher yields. A quality company has both a strong balance sheet and a robust underlying business. It's a three-step process.

Assessing business quality: When assessing a company's quality, certain questions need to be answered. They include how profitable it is; how much debt it carries; how much cash it has, where that cash is coming from and whether it will keep coming; and how well it operates. The indices use the Piotroski scoring system to help. First released in 2000, its nine-point quality test sets the standard when it comes to divining just how financially strong a company is. One point is awarded for each test a company passes. To make it into the portfolios, a company has to score at least seven, though this may be relaxed to five if the index doesn't meet the required minimum number of stocks. The SG indices cannot drift in style or stray from a core competency or mandate. You'll always know what your fund is doing with your money and, perhaps more importantly, how it might perform even as markets change.

Determining balance sheet strength: Once a stock survives Piotroski's scrutiny it is then assessed for balance sheet strength. Here the SG indices use Merton's 'Distance to Default Model', another standard setter. Used by quant managers and ratings agencies alike, it's a mathematical measure that implies a company is worth nothing and will become bankrupt when the value of its debt is greater than the value of its assets. By looking at the current value of a company's assets and how volatile they are, and comparing this to the current value of its liabilities, it is possible to determine how likely a company is to default. Only the top 40% of stocks deemed least likely to default progress to the third stage of the process, though this may be relaxed to the top 60% if the index is too narrow.

Analysing the expected dividend yield: The final filter is expected dividend yield. The SG indices target companies expected to pay a dividend yield of at least 4% at the point of selection. They typically do this using the one-year forward dividend yield as calculated by the Institutional Brokers' Estimate System (IBES). You learn more by looking forward whenever you can. Why look backwards if reported dividend yield can disguise events as seismic as an emissions scandal? When there aren't enough stocks paying 4%, the yield threshold is lowered to 3.5%. The Indices are rebalanced quarterly to ensure they stay true to your goals, and each stock is equally weighted because they are equally good. There's no danger of these indices ever running a long tail of unloved, largely forgotten positions.

Can you explain how the use of swaps enables you to track this index?

At Lyxor, we're committed to using the right method of tracking in each circumstance and we've got no bias towards physical or synthetic. In this case, we find using swaps is better as it allows us to track simply and without having to directly rebalance the portfolio each quarter.