Which ETFs offer the best Japan exposure?

Beauchamp-Chris

The disappointment that pervaded markets following the Bank of Japan’s (BoJ) latest decision to hold fire on further easing will take some time to unwind. However, given the weight of expectations regarding any policy move, it may have been the case that BoJ Governor Haruhiko Kuroda and his team of policymakers thought it was best to hold fire for now.

Instead, the bank may move later in the year, hoping perhaps that the market will remain sceptical and thus accelerate the positive surprise and any downward move in the yen will be greater – with a correspondingly impressive move higher in the Nikkei.

For the time being, the onus lies on the Japanese government to start moving on the area of fiscal policy, something that has been distinctly lacking in recent months. There is speculation that the BoJ’s non-move may well be a prelude to the delay or even abandonment of the government’s planned tax hike. Even if this tax is scrubbed, it will take more than one change in policy to start affecting the radical turnaround that Japan needs.

The economic fundamentals hardly make for pleasant reading right now. The bank has downgraded its assessment of the overall outlook for Japan, having already cut its CPI and GDP forecasts back in January. As the 2 per cent inflation target moves further away, it looks like the task for the BoJ and the Japanese government is as great as ever, if not bigger.

For investors looking at the outlook for Japan, it in some ways makes sense to increase allocations to the Japanese market. The BoJ itself is, as a result of its QE programmes, now a top ten shareholder in 90 per cent of Japanese companies, while the bank also owns around 55 per cent of the nation’s ETFs. The saying goes, ‘don’t fight the Fed’, but perhaps ‘don’t fight the BoJ’ might apply equally well.

Japanperformance

The problem for UK investors where Japanese ETFs are concerned is the currency element. While the ETF itself may do well, yen strength does little to help returns when translated back into sterling. The pound has fallen by some 18 per cent against the yen over the past year, with little sign that this trend is about to reverse.

When looking at the year ahead, there are two possibilities. Either investors take the view that yen strength will continue, or they opt for a strategy that is based on improved performance from Japanese equities. If the former is the preferred view, then a tracker that follows the yen would be the one to choose. However, this view would fly against the prevailing market belief that further easing is likely from the Bank of Japan, along with extraordinary yen interventions from time to time, designed to weaken the currency. Thus, such an ETF could see significant volatility, which may put off investors that are seeking a relatively unexciting investment.

An equity index tracker could provide a simple way of following Japanese stocks, and there are plenty of these available, such as the iShares Japan MSCI ETF. A slightly more exotic ETF would be one such as the Global X Scientific Beta Japan ETF, which looks to shift some of its exposure away from underperforming large-cap stocks and towards the mid-cap end of the spectrum. Such an ETF has also seen lower volatility than the simple trackers, which may prove attractive for some.

The global economy still faces a number of risks, but with central banks still looking to keep policy relatively loose the case for equities can still look compelling. In a world where yields on bonds are still low, investors will have to keep considering stocks as a way of garnering income. In addition, a loose policy environment is likely to prove more conducive for equities, which offers the possibility of capital growth too.

The Bank of Japan still has a lot of work to do in reviving the Japanese economy, but its commitment to the task, despite recent disappointment is not to be underestimated. This therefore suggests that Japan, and Japanese ETFs, should remain on investors’ radar screens.

Chris Beauchamp is senior market analyst at IG Group