Small-caps have been a frustrating asset class this year, and that sentiment extends beyond U.S. borders. With ample frequency, market observers have consistently said smaller stocks look appealing on valuation, among other favorable traits.
They’ve also noted that small-cap stocks were priced in a recession that didn’t arrive. That further highlighted the asset class’ appeal. Still, returns have left investors disappointed, unless they focused on Japanese small-caps. Take the case of the WisdomTree Japan Hedged SmallCap Equity Fund (DXJS).
DXJS, the small-cap equivalent of the popular WisdomTree Japan Hedged Equity Fund (DXJ), concluded October with a year-to-date gain of 33.7%. Alone, that’s impressive. It’s even more impressive when considering, with just two months left in 2023, the MSCI EAFE SmallCap Index, the Russell 2000, and the S&P SmallCap 600 Index are in the red.
More Small-Cap ETF DXJS Benefits
The allure of DXJS doesn’t end there. Through 10 months, the exchange traded fund’s annualized volatility is 16.7%. Conversely, the average annualized volatility on the U.S.-focused Russell 2000 and S&P SmallCap 600 is 18.9%. In other words, DXJS is also delivering better risk-adjusted returns than competing U.S. strategies.
In addition to being supported by the weak yen, the currency-hedged DXJS is deriving benefits from inflation finally emerging in Japan. Some market observers believe Japanese small-caps are poised for more upside. This is because wage growth in the country is moving higher alongside consumer prices.
“In fact, we see wage growth of 3.8% this year, which is at the highest level in the past 30 years. This wage growth should stimulate domestic personal consumption in Japan, which will lead to an increase in corporate earnings. And then we could expect more wage growth for the next few quarters,” noted BNP Paribas investment specialist Sean Patrick.
Though not currency hedged, the WisdomTree Japan Small Cap Dividend Fund (DFJ) also merits consideration. And that’s not just because it’s offered superior risk-adjusted YTD returns relative to MSCI EAFE and U.S. small-cap benchmarks. Because it’s not currency hedged, DFJ could actually benefit should the yen appreciate against other currencies.
“Small-cap companies are more biased to domestic demand-oriented businesses. This appreciation of the Japanese yen would lead to a reduction of import costs for such companies, which should have a positive impact on earnings,” added Patrick.
For long-term investors, DFJ and DXJS offer other benefits in the form of better volatility traits and reduced correlations when measured against equivalent U.S. funds.
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