ETF Trends
ETF Trends

The iShares MSCI Japan ETF (NYSEArca: EWJ) is one of the largest exchange traded funds tracking Japanese stocks and EWJ is surging this year as ex-US developed markets are outpacing the S&P 500. For example, EWJ is higher by 12%, which is well ahead of the S&P 500’s year-to-date gain of just over 9%.

Japanese equities also show more attractive valuations, compared to the pricier U.S. markers. For instance, EWJ shows a 15.42 price-to-earnings and a 1.2 price-to-book, whereas the S&P 500 index is trading at a 18.9 P/E and a 2.6 P/B.

“The focus on Japan limits diversification, but many of the fund’s holdings are major multinational firms,” said Morningstar in a recent note on EWJ. “Companies such as Toyota, Honda, and Sony are among the fund’s largest holdings and have global operations with diversified revenue streams. They also contribute to the fund’s heavier allocation to the consumer cyclical sector compared with broader international funds. This may cause Japan’s performance to differ from these broader portfolios.”

The iShares Currency Hedged MSCI Japan ETF (NYSEArca: HEWJ) and Deutsche X-trackers MSCI Japan Hedged Equity ETF (NYSEArca: DBJP) are among the other well-known Japan ETFs for investors to consider. Like the aforementioned DBJP and HEWJ are currency hedged. However, EWJ and other non-hedged Japan ETFs have been impressive performers this year owing to a surprisingly strong yen.

Still, the Bank of Japan is committed to keeping the yen weak and stirring inflation in the world’s third-largest economy.

The Bank of Japan’s loose monetary policies along with a wider rising rate differentials between the U.S. and Japan could support a depreciating Japanese yen currency over the short-term, which would bolster the export-heavy Japanese market. An issue for EWJ is its lack of exposure to smaller Japanese companies, some of which are delivering impressive returns this year.

“The fund has persistently underperformed the Japan stock Morningstar Category average, likely due to its larger market-cap orientation. Small companies have historically provided higher returns than those having larger market capitalizations. These firms also tend to be more highly leveraged to the fortunes of their domestic economies than their larger counterparts, and so may offer better diversification benefits to U.S. investors. However, they tend to have higher volatility, and the fund has been less volatile than the category average,” according to Morningstar.

For more information on the Japanese market, visit our Japan category.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.