Japan ETFs downgraded as Morningstar reconsiders popular index

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A number of passive funds tracking the MSCI Japan index have been downgraded by Morningstar, which argues it has more conviction that trackers linked to other indices will outperform their peers over time.

UBS, Fidelity, DBXT and Vanguard products have been downgraded from silver to bronze, while the iShares MSCI Japan ETF has dropped from bronze to neutral due to its “unreasonably high management fee”.

Morningstar argues the Topix or MSCI Japan IMI are the broadest and most representative indices.

“It’s all about representativeness and breadth,” says Morningstar director of passive fund research Hortense Bioy. “The broader the index, the harder it becomes for active managers to boost relative returns over the long term through stock selection.”

Morningstar examined recent performance and the structure of the Japanese market, and decided on creating a distinction between indices, Bioy explains.

Morningstar’s Japan Large Cap category includes 20 ETFs with nine tracking the MSCI Japan index. A further two – UBS ETF MSCI Japan SRI and the iShares MSCI Japan SRI ETF – track an SRI version of the index.

“The MSCI Japan is the most popular index to track for Japan. You have fewer tracking the other indices, although Topix is also popular,” Bioy says.

The funds downgraded from silver to bronze are the DBXT MSCI Japan ETF, Fidelity Index Japan, UBS ETF MSCI Japan and Vanguard Japan Stock Index.

Tilney managing director Jason Hollands says there are strong active options for the Japan sector, such as Morant Wright Nippon Yield and Baillie Gifford Japanese, but notes that alternative indices like the FTSE Japan provide broader coverage than the MSCI Japan index.

The former has 492 constituents, while the latter has 320, representing 85 per cent of the market cap.

Trackers that replicate the [FTSE Japan] will therefore end up with more mid-cap exposure and correspondingly greater exposure to businesses that represent ‘new Japan’ rather than traditional flagship industries such as car making,” Hollands says.

Tilney’s preferred tracker is the Legal & General Japan Index, which replicates the FTSE Japan Total Return Index, Hollands says.

Meanwhile, Lyxor or Amundi funds tracking the Topix have received new silver ratings from Morningstar because of their coverage of the broader index.

Morningstar admits the Lyxor Japan Topix DR ETF is considerably more expensive than comparable offerings with its ongoing charge of 0.45 per cent, but argues it maintains a considerable cost advantage compared with active peers.

The ongoing charge for the Amundi ETF Japan Topix is 0.20 per cent.

Bioy says the MSCI Japan could be a suitable index for investors who don’t want exposure to small caps or have a different time horizon.