The Bank of Japan surprisingly recently raised interest rates. And there’s talk that various electoral outcomes in the U.S. could stymie dollar strength. So some market observers believe the Japanese yen could be in for an extended period of upside.
Typically, a strong yen is viewed as a drag on Japanese stocks. That’s because many of the country’s large-cap companies are significant exporters. That means they benefit from converting sturdy foreign currencies into weaker yen. However, the case for Japanese equities doesn’t die simply because the yen gains momentum. In fact, the strong currency could spell opportunity with Japanese small-caps and the WisdomTree Japan Small Cap Dividend Fund (DFJ).
That fund, which doesn’t hedge yen/dollar fluctuations, has been one of the stars of small-cap ETFs, regardless of addressed geography, in recent years. Over the past three years, DFJ returned 8.2%. Both the MSCI EAFE Small-Cap and Russell 2000 indexes posted negative returns over that period. Obviously, that’s in the past, but there’s a compelling case for DFJ going forward.
DFJ, Japanese Small-Caps Have Advantages
As noted in a recent report by WisdomTree, the dividend yield on DFJ’s underlying index is double that of the Russell 2000. And that advantage is sourced in positive fashion. Simply put, many more Japanese small-cap companies pay dividends than do U.S. equivalents. DFJ offers other payout-related benefits.
“US small caps (Russell 2000 Index) are persistent share issuers due to unprofitable companies having to raise more equity to fund expenses,” according to DFJ’s issuer. “Japan small caps are seeing competitive buybacks with their large-cap peers. The 0.95% net buyback yield for the WisdomTree Japan SmallCap Dividend Index is in the same ballpark as that of the MSCI Japan Index and not too far behind that of the WisdomTree Japan Hedged Equity Index.”
Reduced-Volatility Benefit
The commitment of Japanese small-cap firms to shareholder rewards and strong balance sheets benefit investors in another way: reduced volatility. For the three years ending Aug. 15, the average annualized volatility on the Russell 2000 and S&P SmallCap 600 indexes was 22.5%. That’s well ahead of the 15.7% sported by DFJ.
As WisdomTree noted, DFJ’s volatility metrics confirm that smaller Japanese stocks aren’t exotic. Nor is the asset class as volatile as some investors may believe.
“Are Japanese small caps too exotic? Frequently, ‘exotic’ becomes somewhat of a dirty word in investment strategy depiction because the volatility is so far beyond more familiar exposures. What’s notable is that Japan small caps are one of the lower volatility equity exposures one can include in a portfolio,” added the issuer.
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