There is Asia and then there is Japan. For a decade ETFs
representing markets in China, Hong Kong, Singapore, Australia,
Korea have been some or the best performing in the market. For a
decade, Japanese ETFs have been among the worst-performing. What
is wrong with Japan? Can anything pull Japanese ETFs out of the
The situation in Japan is well-known. The post-war miracle
boom peaked in the eighties as a surge in domestic Japanese
demand supplemented export revenue. During the eighties,
investment in Japan was fueled by an increasingly valuable
currency that made foreign assets cheap for Japanese and drove up
prices at home. Prices of stock and real estate skyrocketed--
then collapsed. Banks with massive portfolios of non-performing
loans became insolvent. Japan has never recovered from this bust.
The chart below shows the long-term performance of the Japanese
stock market index, the Nikkei.
Short of throwing money out of helicopters, it is probably
fair to say that the Japanese have tried just about everything to
spur their economy rate cuts, currency management, spending,
stimulus. Despite this, Japan today has multiple ills widely
considered intractable: lack of domestic demand, poor
demographics (an aging population), persistent deflation, and
massive debt. Macro numbers are staggeringly bad. Japans debt is
about 200% of GDP, the highest by this measure in the world after
Zimbabwe. S&P recently cut Japans debt rating to AA-, its
fourth highest rating.
The usual cure for too much debt is to increase growth by
spurring investment and consumption. On the investment side, the
Bank of Japan has had interest rates essentially at zero for a
decade. Money is already free. It is hard to go further. On the
consumption side, the Japanese consumer, though prodded prefers
to save. Currently below 60% of GDP, consumption lags the U.S.
and Europe. This makes it difficult for Japan to grow its way out
of debt. Unlike in the U.S., where a lot of debt is owned
externally (by China and others), most of Japans debt is owned
internally, to its citizens, who in the wake of the Japans
banking crisis mistrust banks. This leaves Japan vulnerable to
its demographics. As its citizens age they will need some of the
money they have invested in Japanese bonds.
But surely some of this is priced in? Maybe but, with the
exception of a big run in 2003, Japanese ETFs have not kept pace
with the rest of Asia. The chart below compares the granddaddy of
Japanese ETFs, the iShares MSCI Japan (NYSEArca:EWJ) with FTSE
China (NYSEArca:FXI), Hong Kong (NYSEArca:EWH) and Australia
The chart shows that over five years Asian ETFs of did well.
Japan's EWJ provided investors with negative returns. (But
notably it did not suffer the steep drop during the financial
crisis of Chinas FXI). Though most investors do not look to Japan
for growth, ETFs like EWJ are good for diversification and
stability. Japan is stable both economically and politically.
According to Country Watch, which publishes a political stability
index, Japans politics are highly stable, with a score of 9.5 of
a possible 10.
Still, some investors dare to hope for more. They argue that
investors should be willing to pay more for stability, not less.
Typically Chinese stocks trade at multiples of book value. By
this measure Japan is cheap. Shares of well-established companies
like Mitsubishi Financial and Toyota Motors, big holdings in
Japanese ETFs trade at and even below book value.
In addition to EWJ investors looking for exposure should
consider WisdomTree Japan Hedged Equity (NYSEArca:DXJ) and small
cap funds, Japan Small-Cap Dividend (NYSEArca:DFJ) and SPDR
Russell/Nomura Small Cap Japan (NYSEArca:JSC). For property
exposure iShares FTSE EPRA/NAREIT Developed Asia Index
(Nasdaq:IFAS) offers about 25% exposure to Japan.
Other than the valuation argument, the best thing for Japan
ETFs would be restarting the machine that powered it to the
world's second largest economy in the sixties and seventies:
export. If China is the big winner of globalization, then the
U.S. and Japan are the big losers. Japans export machine has
slumped as China has become the worlds manufacturer. Chinas
currency policy in particular has hurt Japanese exports. The
Chinese currency is pegged to the dollar. The euro and the yen
have had to weaken against a dollar prevented from weakening
against the Chinese yuan. The yen now stands at decade long highs
against the dollar. This makes it difficult for Japanese
companies to export.
The fate of Japanese export ambitions may be decided in
Beijing. If China allows the dollar to fall against the yuan,
this will take some pressure off the yen. A weaker yen would mean
more demand for exports. If the dollar strengthens against the
yen, as it has been recently, Japanese ETFs will lose value in
dollar terms. An ETF investor wants a yen weak enough to permit
exports and encourage asset prices to increase and strong enough
to keep the value of Japanese holdings from substantial
depreciation in dollar terms.
Below a list of key Japanese ETFs and expense
iShares MSCI Japan (NYSEArca:EWJ), 0.54%
iShares MSCI Japan Small Cap Index Fund (
iShares S&P/TOPIX 150 Index Fund (
ProShares UltraShort MSCI Japan Fund (
SPDR Russell/Nomura Small Cap Japan ETF (
WisdomTree Japan High-Yielding Equity Fund (
WisdomTree Japan Small Cap Dividend Fund (DFJ), 0.58%
WisdomTree Japan Total Dividend Fund (DXJ), 0.48%
iShares FTSE EPRA/NAREIT Developed Asia Index (Nasdaq:IFAS),
has been writing about ETFs since 2003 and is the author of
Sector Trading: A Year in Exchange Traded