The Japanese stock index is at a 33-year high, a result of myriad factors. Some of these include the Oracle of Omaha Warren Buffett highlighting the opportunity in the region and upping his stake in Japanese trading companies, and the expectations of the new Bank of Japan governor Kazuo Ueda’s approach to monetary policy.
The net result is that investor interest in the region has grown. It’s too early to call whether the market is finally walking out of its ‘lost decades,’ but capital inflows continue to flock into the market. In May of 2023, offshore funds investing in Japan large-cap equities recorded net subscription of US$ 3 billion, second to only global large-cap blend equity funds.
In Japan, Corporate Reforms Start to Bear Fruits
Daniel Hurley, portfolio specialist for emerging market & Japan equities at T. Rowe Price, says: “Japan is certainly recovering from the pandemic. The corporate governance reforms implemented over the past seven years are finally starting to be appreciated by foreign investors.”
To his mind, there are two groups of opportunities.
- The potential of quality growth companies that can compound earnings growth into the future, and
- Transformation companies that are improving governance and shareholder returns.
“Abenomics laid the groundwork for corporate governance reforms in 2015 but we now have evidence of this in higher shareholder returns… We are only at the start of the market appreciating this,” continues Hurley.
He sees overseas investors being net buyers of Japan since the second quarter of this year. However, in his own portfolios, he remains underweight in the region. He believes there’s plenty of further improvement to be made.
For example, the Tokyo Stock Exchange stresses that ‘they are not happy with the number of companies with a price-to-book below 1.’ The Japanese bourse said it will request companies trading below book value to come up with capital improvement plans.
Meanwhile, he advises that investors should monitor how the Bank of Japan normalizes monetary policy over the coming 12 months. “This will be a fine balancing act; tighten too much, too quickly and they will strengthen the currency and impact the exporters that much of Japan’s economy and the TOPIX index relies upon, this could derail the inflation that the Bank of Japan has fought to generate for twenty years,” he says.
Top ETFs for Japan Equity Exposure
For investors who want to buy the Japan story, ETFs are practical tools for achieving this very specific exposure. We looked up Morningstar’s research and proprietary data for the top ETFs with exposure to the region. Five ETFs have a Morningstar Medalist Rating of Silver or better. They are U.S.-listed vehicles, but are accessible via local brokers.
Let’s look at the gold-rated funds in some detail.
iShares JPX-Nikkei 400 ETF JPXN earns a Gold medalist rating. The equity team managing the passive strategy drives the strategy’s Above Average People Pillar rating, because of the strategy’s unique investment approach.
Launched in 2001, the strategic beta strategy leans toward larger, more value-oriented companies. The portfolio has maintained an underweight position in volatility exposure and has an overweight in yield exposure compared with category peers. According to Morningstar’s analysis, the ETF’s managers have consistently had exposure to low-volatility stocks over the past few years, or those whose relative returns look best when the markets are their worst. Such holdings can limit a strategy's downside but cause it to lag in bull markets.
The strategy owns 398 securities, and its assets are more dispersed than peers. The portfolio is overweight in healthcare versus the category average, and its industrials allocation is similar to the category. The sectors with low exposure compared to category peers are consumer cyclical and financial services.
iShares MSCI Japan Value ETF EWJV is another iShares’ ETF strategy that earns a Gold Morningstar Medalist Rating. The strategy has an Above Average People Pillar rating while the strategy's investment approach earns an Above Average Process Pillar rating.
This strategy skews toward larger, more value-oriented companies compared with its average peer in the Japan Stock Morningstar Category. According to Morningstar analysis, this strategy tilts consistently toward stocks with lower quality or the shares of companies with more financial leverage and lower profitability.
Unlike the JPX-Nikkei 400 ETF, the value portfolio composed of 146 holdings is relatively concentrated. The portfolio is overweight in financial services and industrials. In its top 10 holdings, which amounts to 35% assets in the strategy, the strategy owns four bank and insurer names, including Mitsuibishi UFJ Financial Group and Sumitomo Mitsui Financial Group. Top industrial names are Mitsubishi Corp and Hitachi Ltd.
JPMorgan BetaBuilders Japan ETF BBJP earns a High Process Pillar rating, and abundant experience on the portfolio management team earns an average People Pillar rating.
By sector, the JPMorgan ETF’s allocations are similar to category peers. While healthcare and consumer cyclical are its top two sectors, it has lower exposure to financial services and consumer defensive.
The strategy shows it has maintained an underweight position in volatility exposure and quality exposure compared with category peers. As of Jun 15, the biggest three holdings of the 277-stock index tracker are Toyota Motor, Sony Group and Keyence. Another plus for this fund is that its fee level is currently in the cheapest quintile of its Morningstar Category.
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