Why Japan ETFs May Be Value Play

October 10, 2017

Japan equity ETFs have been largely out of favor for much of 2017, despite strong investor appetite for international stocks such as Europe, and emerging markets in search of outsized returns. The tide, however, could be about to turn.

Some of the largest Japan ETFs have all bled assets year-to-date. The iShares MSCI Japan ETF (EWJ) has seen $1.2 billion in net outflows in the first nine-plus months of the year. The WisdomTree Japan Hedged Equity Fund (DXJ) has lost about $550 million in net assets, and the Xtrackers MSCI Japan Hedged Equity ETF (DBJP) has faced $645 million in net redemptions.

These funds have performed relatively well, delivering roughly half the gains of an allocation to a broad emerging market ETF such as the iShares Core MSCI Emerging Markets ETF (IEMG). (IEMG has seen more than $13 billion in net inflows year-to-date.) They are each up around 12-15% this year despite the outflows. 

 

 

Weak Dollar & Japan

One of the key factors that has been weighing on Japanese stocks is the weakness in the U.S. dollar, which has dropped more than 8% this year, and at one point it was down 12% from early-year highs.

According to Russ Koesterich, portfolio manager for BlackRock’s Global Allocation team, a weak dollar may be good news for emerging market equities, but it doesn’t typically bode well for Japanese stocks.

The dollar may be about done with its downward run, he says. In the past month alone, the dollar has climbed about 2%.

“Selling dollars has become a bit too popular, and the greenback has started to stabilize,” Koesterich said in a recent blog. “A stable or appreciating dollar would likely prove a modest headwind for EM equities and a tailwind for Japanese stocks.”

Japan A Value

Valuations are another attractive feature of the Japanese market right now—much like emerging market valuations were in late 2016 after a major sell-off. Japan stocks are trading at a deeper discount relative to world stocks than they historically average—a 42% discount to the MSCI World Index versus a 20-year average of 32%, Koesterich notes.

“Against EM stocks, Japan appears even cheaper,” he said. “Since 1995, Japan has typically traded at a 12% premium to EM equities based on P/B [price-to-book]. Today the TOPIX trades at a 23% discount to the MSCI Emerging Market Index. This represents the largest discount since the spring of 2014, a period that preceded a 50% rally in the TOPIX.”

In 2016, Japan equity funds barely finished the year in the black, with funds like EWJ and DXJ up 2% and 1%, respectively, that calendar year. Japan ETFs have delivered a bit of a roller-coaster ride since Shinzo Abe first returned to the prime minister spot in December 2012, with nonhedged and currency-hedged strategies such as EWJ and DXJ each facing periods of strong performance and losses. 

 

Charts courtesy of StockCharts.com

 

 

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