As investors re-allocate their portfolios in anticipation of a rising interest rate environment, many are considering Japanese equities and country-specific ETFs to benefit from U.S. Federal Reserve rate hikes.
“As pressures build for rising interest rates, we believe investors should consider both Japanese broad market exposure and ETFs, as well as Japanese Financials, to supplement some other U.S.-sensitive rising rate plays like U.S. Financials,” Christopher Gannatti, Associate Director of Research for WisdomTree, said in a research note.
For instance, investors may consider options like the WisdomTree Japan Hedged Financials Fund (NYSEArca: DXJF), which tracks the Japanese financial sector and hedges against a depreciating yen currency, or the WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ), a currency-hedged broad Japan option, to access the Japanese equities markets.
WisdomTree has found that the MSCI Japan Financials Index has exhibited some of the strongest inverse correlation to U.S. rising interest rates. Over the nearly five-year period ended September 2017, Japanese financials have shown even greater sensitivity to rising U.S. interest rates than U.S. financials.
Furthermore, a rising rate picture in the U.S. 10-year Treasury note has been closely related to the weakening of the Japanese yen against the U.S. dollar, which has helped support Japan’s export-oriented economy.
A weakening yen currency may weigh on Japanese equity investments. However, a currency-hedged ETF option like DXJ would allow investors to access a growing Japanese market and limit the negative foreign exchange risks associated with a falling yen currency. Furthermore, DXJ’s underlying WisdomTree Japan Hedged Equity Index is designed to exclude companies that derive more than 80% of revenue from within Japan, which contributes to the portfolio’s export industry tilt.
“Since the beginning of the Abenomics period, the performance of Japan’s equities has ebbed and flowed, but if one were to ask what were the best times to allocate toward Japan, the data here suggests that it was clearly during rising U.S. rate periods. Financials and exporters did very well, on average, over these periods, as did U.S. small caps,” Gannatti said, citing data from the five-year period ended November 2017.
For more information on the Japanese markets, visit our Japan category.