Shrinking Japan GDP Shifts ETF Outlook

August 13, 2014

Currency-hedged Japan ETFs are facing head winds as growth slows, but that’s not the whole story.

Japan’s slowing economic growth is hurting investment returns for those betting on the world’s No. 3 economy, and investors seem to be fine-tuning their approach. They are pulling out of the market’s most popular currency-hedged ETF strategy while plowing money into ETFs that make the dollar-yen cross part of fund returns.

Today’s report showing sharply negative growth in the second quarter shows why Japan investment returns have turned negative this year after 2013’s impressive 57 percent gain for the Nikkei 225. The Nikkei is down 4.5 percent this year.

New taxes are denting economic growth, though those have been expected as part of “Abenomics,” the country’s overall economic overhaul. The government there said today that GDP growth turned negative in the second quarter to the tune of -6.8 percent—worse even than the first quarter of 2011, which included the devastating earthquake-tsunami and nuclear disaster in March of that year.

As noted, ETF investors haven’t abandoned the Land of the Rising Sun, but they do seem to be fine-tuning their approach.

The WisdomTree Japan Hedged Equity Fund (DXJ | B-61), 2013’s ETF of the year, has had outflows in 2014 of about $2.3 billion, while the iShares MSCI Japan ETF (EWJ | B-97) has had inflows of $1.1 billion, according to’s data screener.

Also, the nearly $10 billion DXJ has fallen 1.4 percent this year, while the close-to $15 billion EWJ has lost 0.92 percent—with much of the difference linked to the currency cross. Year-to-date, the yen has gained about 2.5 percent against the dollar after dropping some 20 percent last year. Last year’s weakening yen was a big reason DXJ was such a hit, in terms of both inflows and returns.

“People are starting to realize that maybe the yen isn’t going to continue tanking this year, and EWJ has outperformed DXJ,” said Dennis Hudachek, senior ETF analyst at “That’s why people are moving their money into EWJ and out of DXJ.”

Abenomics—Prime Minister Shinzo Abe’s three-part economic reform plan that includes quantitative easing, fiscal stimulus and structural reforms to the world’s No. 3 economy—was a hit last year. Abe unveiled the first two “arrows” last year. But the third arrow involving tax increases appears to be creating head winds.

The question ahead is whether this new consumption tax will create a long-term drag on the economy, or, conversely, if the taxes will help improve Japan’s fiscal imbalance enough to create new tail winds. After all, Japan is home to plenty of super-successful global brands like Honda, Mitsubishi, Toyota and even the somewhat-faded Sony.


Chart courtesy of

Notwithstanding the challenges that the currency-hedged fund DXJ is up against this year,’s Hudachek reckons it may make more sense to put on a currency-hedged position in Japan. He argued that the case is starting to build for more quantitative easing from the Bank of Japan sometime next year, as the latest GDP report may be suggesting.

Investors looking for Japan equities exposure via hedged or unhedged vehicles can get it using the following ETFs:


Deutsche X-Trackers MSCI Japan Currency Hedged Fund (DBJP | B-69) AUM: $520 million; YTD returns: -3.9 percent

DBJP tracks a currency-hedged version of the popular MSCI Japan Index, the index tracked by iShares' popular blockbuster fund, EWJ.

Unlike most international ETFs, DBJP hedges out the currency exposure inherent in investing in its underlying equities, resulting in the fund missing out on the returns and/or losses associated with an appreciating/depreciating Japanese yen.

At 0.45 percent, or $45 for every $10,000 invested, DBJP is now the cheapest fund in its segment.

WisdomTree Japan Hedged Equity Fund (DXJ | B-62) AUM: $9.88 billion; YTD returns: -1.4 percent

DXJ, named the 2013 ETF of the year, tracks a dividend-weighted index of Japanese stocks and is hedged for currency fluctuations between the dollar and the Japanese yen.

The fund selects export-oriented Japanese companies, dividend-weights them and hedges its yen exposure, positioning itself to gain from increased trade and a devalued currency. The dividend-focused screen lends the portfolio something of a value tilt.

DXJ wasn’t always currency-hedged or export-oriented. At launch in June 2006, it tracked a dividend-weighted index, adding a currency hedge in 2010, and shifting the portfolio toward exporters in November 2012.

DXJ’s low expense ratio—0.48 percent—makes it relatively cheap to hold.

iShares MSCI Japan ETF (EWJ | B-97) AUM: $15 billion; YTD returns: -0.92 percent

EWJ tracks a market-cap-weighted index of Japanese stocks and covers roughly 85 percent of the investable universe of securities traded in Japan. Launched in 1996, EWJ was the first Japan-focused ETF to come to market and quickly became the bellwether for U.S.-based investors wanting Japanese market exposure since.

With an annual expense ratio of 0.50 percent, the fund is close to the cheapest in its segment. When it comes to liquidity, EWJ is a market leader—the fund trades more than $400 million on most days, at pennywide spreads.

With almost $15 billion in assets and strong liquidity, EWJ sets itself apart within the segment.

SPDR Russell/Nomura PRIME Japan ETF (JPP | D-98) AUM: $27 million; YTD returns: -0.6 percent

JPP tracks a market-cap-weighted index of Japanese securities that represent about 96 percent of the Russell/Nomura Total Market Index. Costing 50 basis points, JPP does the best job of providing broad exposure to the Japanese equities market, according to analysts at

JPP falls a bit short when it comes to liquidity: The fund trades only $200,000 on most days at wide average spreads. The fund hasn’t caught on with investors since its November 2006 launch.

First Trust Japan AlphaDex Fund (FJP | C-31) AUM: $141 million; YTD returns: +3.77 percent

FJP tries to beat the broader Japanese equity market using a proprietary selection model and tiered equal-weighting scheme. The fund underweights financial stocks, which Hudachek mentioned are poised to benefit from Abenomics. FJP also loads up on technology stocks while tilting heavily toward midcap stocks in its attempts to find alpha.

Costing 0.80 percent, FJP is the most expensive fund within the segment, and tracks its index loosely. The fund’s average trading spread is 0.42 percent, so liquidity is also an issue here.


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