“We see global reflation and a weak yen propelling Japanese stocks higher on a currency-hedged basis,” Richard Turnill, Global Chief Investment Strategist at BlackRock, said in a research note.
Supporting the Japan outlook, the yen currency has been weakening. The U.S. dollar is now trading at around ¥116.19. The weaker yen boost earnings of Japanese exporters in local currency terms as their wares become more competitive in international markets.
“Forward earnings in Japan closely tracking the dollar/yen rate in recent years,” Turnill said.
“Japanese earnings estimates are rising. The three-month change in 12-month forward earnings estimates is near a two-year high. Japan’s relatively low corporate profit margins mean a given increase in revenues can have an outsized impact on earnings. A one percentage point increase in real global gross domestic product (GDP) growth has historically delivered a 21% boost to Japanese earnings, our analysis of the past 35 years shows, versus just 5% in the U.S.,” the strategist added.
A depreciating yen also makes Japanese assets cheaper or more attractive for foreign investors.
Moreover, the currency is likely to remain depressed against the greenback as zero-yield 10-year Japanese government bonds push local investors to buy higher-yield foreign bonds, like 10-year U.S. Treasuries, which further depreciates the yen as local buyers trade in their money for U.S. dollars.
Consequently, investors who are interested in gaining exposure to this segment of the global market have a number of ETF options to choose from, with currency-hedged strategies currently outperforming as the Japanese yen depreciates against the U.S. dollar.
The WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ), iShares Currency Hedged MSCI Japan ETF (NYSEArca: HEWJ) and Deutsche X-trackers MSCI Japan Hedged Equity ETF (NYSEArca: DBJP) have been go-to options to access Japanese equities markets while hedging against foreign exchange risks, but potential investors should keep in mind that the funds could underperform non-hedged funds if the yen strengthens.
Moreover, investors may also consider hedged ETFs that track the more recently launched JPX-Nikkei 400 Index. The JPX-Nikkei 400 Index was launched in January 2014 as a means of reinvigorating the Japanese equity market. The Index employs a rigorous screening process based on return on equity, cumulative operating profit and market capitalization to select high-quality, capital-efficient Japanese companies. As part of the Abe administration’s revitalization plan, the BOJ and large state funds have steered away from conservative bets for riskier equity exposure, including ETFs that track customized benchmarks like the JPX-Nikkei 400 Index.
U.S. ETF investors can also track the benchmark index through relatively new offerings, including the Deutsche X-trackers Japan JPX-Nikkei 400 Hedged Equity ETF (NYSEArca: JPNH) and iShares Currency Hedged JPX-Nikkei 400 ETF (NYSEArca: HJPX).
Alternatively, if you still have an uncertain outlook on the Japanese yen and U.S. dollar, an ETF investor may consider alternative options that take a more neutral view on foreign currency movements. For instance, IndexIQ has a handful of 50% hedged/50% unhedged option, including the IQ 50 Percent Hedged FTSE Japan ETF (NYS Arca: HFXJ).
ETF investors may also look to some relatively new dynamic or adaptive currency-hedged international stock strategies. For instance, BlackRock offers the iShares Adaptive Currency Hedged MSCI Japan ETF (BATS: DEWJ), which may shift from a 0% unhedged currency exposure to a 100% fully hedged, depending on differences in interest rates, relative valuations, currency momentum and currency volatility.
WisdomTree also offers the WisdomTree Dynamic Currency Hedged Japan Equity Fund (BATS: DDJP), which hedge currency fluctuations in the relative value of the foreign currency against the USD, ranging from 0% to 100% hedge based on interest rate differentials, valuations and relative price momentum of the foreign currencies compared to the USD.
For more information on the Japanese markets, visit our Japan category.