Investors will soon have access to the 'Nikkei,' Japan's most widely followed stock index, through an ETF. But will it be better than existing options?
Last month, Precidian Investments filed with the Securities and Exchange Commission to market the MAXIS Nikkei 225 Index Fund, which will trade on the New York Stock Exchange's electronic trading platform Arca under the ticker "NKY." It's astonishing no one has pulled this off yet, as the Nikkei is as synonymous to Japanese stocks as the Dow Jones Industrial Average is to U.S. stocks.
The Nikkei 225 Stock Average is a price-weighted index of 225 Japanese securities that trade on the Tokyo Stock Exchange. According to the N-1 filing, the new fund's annual expense ratio will be 0.50 percent, and will replicate the Nikkei 225 Index. That said, the paperwork left open the option to use a "sampling" strategy in cases where replication is not possible or practical.
Currently, the iShares MSCI Japan Index Fund (NYSEArca: EWJ) is the "big daddy" of all Japan ETFs, and has been the de facto way for U.S. investors to gain exposure to Japanese equities since the fund's inception in 1996. EWJ uses an optimization strategy to track the MSCI Japan Index, a market-cap-weighted index of over 300 Japanese securities. It has over $7 billion in assets under management and has an annual expense ratio of 0.54 percent.
There are big differences between EWJ and the new Nikkei 225 fund in the structure of their underlying indexes that potential investors will need to weigh. However, a big factor that's often overlooked when analyzing Japan ETFs is exposure to the Japanese yen.
EWJ is not currency hedged, and according to the N-1 filing, the new Nikkei fund won't be either. Therefore, since both funds will be priced in dollars, investors in the funds will also be inherently long the yen.
That's where the WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ) comes into play. DXJ is currently the second-largest Japan ETF, with $548 million in assets under management. Its holdings are fundamentally weighted, based on annual dividends paid. But what truly separates DXJ from its peers is the currency hedge it deploys.
DXJ provides a unique strategy by going long Japanese equities while hedging its exposure to the Japanese currency by shorting yen forward and futures contracts. This means that the fund is designed to outperform its nonhedged peers when the yen weakens. The opposite is also true: It's structured to underperform its nonhedged peers when the yen strengthens.
This yen hedge is significant because Japan's economy has historically benefited from a weaker yen, partly because Japan is so heavily dependent on exports. And, as a WisdomTree research paper highlights, Japan has had a negative correlation between its stock market returns and its currency movements over the past three years.
The yen has been on a tear in recent years—it's gained over 30 percent against the dollar since bottoming out in July 2007. Then, in the wake of the Tohoku earthquake and tsunami in March, the yen strengthened so much that the Group of Seven Nations (G7)—France, Germany, Italy, Japan, Canada, the U.K. and the U.S.—intervened in currency markets for the first time in over a decade to halt any further yen appreciation.
It's difficult to know how effective this coordinated effort by the central banks of the G7 will be, but the last time the G7 intervened in the fall of 2000—that time to stabilize the slide in the euro—it happened to coincide with the bottom in the euro a month later. So the significance of this move by the G7 cannot be ignored.