Rediscovering Japan Through ETFs

Japan, once the largest stock market in the world, is again providing exchange-traded fund investors with motivation to take a closer look. Optimism about some long-awaited changes in economic policy, a stable currency and attractive fundamentals have started to bring foreign investors back.  

The key now is whether this is merely a trading opportunity or a time to truly rediscover Japan as a core part of portfolios. 

"Discovering Japan" was a 1979 song by British rock musician Graham Parker. It was not released as a single, but fans loved it anyway, and it became one of his most popular songs. The Japanese stock market had its heyday not long after that song was released. And since 1991, it has just been trying to get back there.  

Japan's Nikkei stock market index peaked in 1991—as in, last century. Thirty-two years later, it finally recaptured that high level.  

Decades of slow economic growth, a large elderly population creating a strain on Japan’s social security system, and persistent low interest rates conspired to make Japan, once the largest stock market in the world, a complete afterthought.  

Since 2013, the Bank of Japan has made a concerted effort to keep yields on 10-year Japanese government bonds within a 0.5% range either side of 0%, what is known as the BoJ’s yield curve control economic policy.  

That was more acceptable to investors when global inflation was also near zero, but those days are gone. For some, that news is a game-changer that reopens Japan as an investable equity market, potentially ending decades of stagnation.  

In a world equity market where “overvalued” seems to be the stock market’s middle name, there is an increasing tide of enthusiasm for Japanese equities. The country’s stock market generally offers investors a relatively low P/E ratio and lighter emphasis on technology stocks than many developed markets.  

Japan’s Greastest Hits 

The iShares MSCI Japan ETF (EWJ) is the biggest, longest-tenured Japan-focused equity ETF, with over $10 billion in assets and an inception in March 1996, just five years after that long-term market top. It sells at a reasonable 16x trailing earnings, and yes, its price has gone literally nowhere for 27 years. It debuted at about $63 a share, and currently sits around that same level.  

The Wisdom Tree Japan Hedged Equity Fund (DXJ) is another mature ETF, having debuted back in 2006. Its most unique feature is that it hedges its equity portfolio versus the Japanese yen, so that the ETF’s performance will solely reflect the performance of its exporter-focused stock mix. Fundamentally speaking, DXY is compelling, with its portfolio selling for only 8.3x earnings, 1.0x book value and yielding 3.5%. 

The iShares MSCI Japan Small-Cap ETF (SCJ) offers another way to invest in the Land of the Rising Sun. This is a small ETF, both in the size of the stocks it owns, and just under $70 million in assets. It owns more than 800 positions, so there’s no concentration risk here. And it is off to a nice start in 2023, with a gain of 8%. 

All of these ETFs have a much lower technology industry weighting than the S&P 500’s 27% allocation. EWJ’s tech exposure is 17%, while DXJ and SCJ are in the 10% area. So, for investors who were starting to think that it's tech or nothing in 2023, discovering Japan could be a timely tune.