ETF Showdown: Comparing Japanese ETFs

[This article was first published in the December 2015 issue of ETF Report UK]

We compare and contrast two ETFs competing to provide exposure to Japan equities, looking at expenses, tracking, trading volumes, liquidity and exposure.

Why Invest In Japanese Equities?

Ever since Shinzo Abe was elected Prime Minister in December 2012, investors have watched as his three-arrow socioeconomic programme has boosted the domestic stock market, targeted higher inflation and driven through corporate reforms.

When Japanese equities shot up in 2013, the yen was decimated, bringing in a wealth of currency-hedged ETFs from opportunistic providers. But in 2015 major currencies like the USD, GBP and EUR have all depreciated against the yen and unhedged exposure to Japanese equities is now a popular trade.

The Government Pension Investment Fund is allocating more capital to equities and the Bank of Japan promises to keep buying up Japanese equity ETFs—all good signs for the stock market.

What Options Exist For Investing In Japanese Equities?

We will focus on two ETFs that track this equity market:

• Lyxor JPX-Nikkei 400 UCITS ETF (JPX4)
• db X-trackers MSCI Japan Index UCITS ETF (XMJP)

In an attempt to compare apples to apples, these funds accumulate dividends and are not currency hedged.

Although the Topix and the Nikkei 225 are the most well-known indices to measure Japan, new and exciting heavyweight indices are the focus here because they offer more diversified exposure, and the JPX 400 tracks companies that are driving corporate reform.

What Indices Do They Track?

The Lyxor fund tracks one of the most popular new indices of the past two years—the JPX Nikkei 400, which has a lot of appeal for investors looking to get a foothold in Japan. It is specifically designed to focus on companies that are driving shareholder value through corporate reform, dividends and share buybacks. Stocks are not only selected by their market cap but also their trading value, return on equity and other factors.

Meanwhile the db X-trackers fund is focused on MSCI Japan, a market cap weighted index which tracks 291 mainly large cap and midcap companies.

Are The Indices Concentrated In Certain Sectors?

The db X-trackers ETF is slightly more concentrated in terms of the number of underlying constituents, but the universe of large and midcap stocks is broadly similar to the Lyxor fund.

JPX4's top holdings are telecom firms Nippon Telegraph & Telephone and KDDI Corporation, along with Honda Motor and Japan Tobacco.

XMJP's top holdings are different: Toyota constitutes a significant 5.9% of the fund, followed by a combined 4.8% in Mitsubishi and Sumitomo Mitsui financial groups.

However, for both funds, investors are taking a bet on financials, industrials and consumer discretionary sectors, with a fairly heavy chunk—10%—in information technology stocks.

How Do They Replicate The Index?

Both ETFs are physically replicated, meaning the ETF manager will go directly into the market and buy the underlying securities, instead of using derivatives to mirror the index.

How Much Do They Cost?

The Lyxor fund has an all-in fee of 0.25%, while the db X-trackers alternative is 0.50% per year.

It's worth noting that both providers offer more Japan ETFs—db X-trackers has a Nikkei 225 ETF for just 0.09% fees, and a JPX-Nikkei 400 ETF for 0.20%. Lyxor offers just one other Japan ETF, which tracks the Topix, for 0.45% in fees.

How Do They Compare On Liquidity?

In terms of fund size, both ETFs are the largest in Europe in terms of assets under management (AUM) that track their respective indices. JPX4 only launched in September last year but has already grown to a healthy £506.5 million. Db X-trackers' XMJP came to market much earlier—in January 2007—and has £1.1 billion AUM. Both figures are as of 7 Oct., 2015.

Both funds trade on the London Stock Exchange (LSE), but XMJP appears to be more liquid.

XMJP trades a fairly small number of times, with a high peak of almost 300 trades in April, but on average the number is closer to 50 trades per month. Valuewise, those trades amount to an average of around £500 million. This suggests there are more institutional investors interested in the fund than retail.

Lyxor's JPX4 had a peak of over 500 trades in April, with a normal month much lower, at around 50 trades. In terms of value, it usually comes to less than £50 million.

The bid/offer spread for JPX4 is 0.33% and for XMJP is 0.22%, both as of 7 Oct.—hardly surprising considering JPX4 is a newer fund with fewer assets.

How Have They Performed?

Both funds have delivered positive returns year-to-date as of 7 Oct., which is good news for investors after a choppy third quarter, which pushed most ETFs into the red.

XMJP has edged ahead YTD at 7.8% versus JPX4's 5.9%. XMJP wins again over one year, with returns of 10.4% compared to JPX4's 4.7%.

XMJP has a longer track record and has delivered a pleasing 12.7% over three years and a modest 5.7% over five years.

However, when it comes to tracking difference, XMJP could do better. Since launch, the index has fallen 6.1%, while the ETF has slipped 10.2%. Lyxor converted its JPX4 ETF in July from synthetic to physical replication to improve tracking performance.

Is One Better Than The Other?

Retail investors would be happy with both funds' positive returns considering a difficult 2015, although the annual costs are higher than the costs of similar funds from some other providers.

Db X-trackers' XMJP has performed better in terms of YTD and has a longer track record, and also seems more liquid on the LSE. The question an adviser will have to answer is whether they want a more concentrated index and how much they care about tracking difference—surely a lot more if they are investing for the long term.

Without doubt, JPX4 is more of a punt as it tracks a newer index. But reform-minded investors will be attracted to the so-called extra shareholder value as well as the lower product fees. Those that employ a buy and hold strategy won't mind the lighter trading activity.

What Other Options Do I Have?

There is a plethora of Japanese equity ETFs that track the Topix, the Nikkei 225, MSCI Japan Index and the JPX 400, from most European providers. On last count, there are more than 40 ETFs to choose from, including currency hedged funds.

There are now six providers in Europe that have launched funds off the back of the JPX Nikkei 400 index–Source, Amundi, Lyxor, iShares, db X-trackers and Nomura. Amundi's fund is cheapest, at 0.18% fees.

For progressive, green-minded investors, the UBS MSCI Japan Socially Responsible UCITS ETF (JPSR) costs 0.40%, is physically replicated and tracks 72 large and midcap stocks. However, it still has very few assets and may not be as liquid as more established ETFs.