Last week, I called out 10 overlooked ETFs that I thought deserved more assets. This week, I want to focus on a couple of Asian ETF giants that I think are among some of the most overrated funds in the industry.
The two ETFs I'm referring to are the iShares FTSE China 25 Index Fund (NYSEArca:FXI) and the iShares MSCI Japan Index Fund (NYSEArca:EWJ). Thus far, these two ETFs have become the de-facto ETF plays for investors wanting exposure to the world's second- and third-largest economies.
Not surprisingly, both of these funds were first-movers into their respective pockets. Today, many investors continue to pile assets into them based on their popularity, but it is time to reexamine whether they're really the best of the bunch, or simply overrated.
Let's first start with the $7.9 billion FXI, because this fund probably tops my list of all overrated ETFs.
I understand why there was so much excitement over FXI when it launched in 2004. It was, after all, the first China focused ETF available to U.S. investors, but that was eight years ago.
Chinese markets have come a long way since 2004, and so has the China ETF landscape. Since then, more than 20 China ETFs have launched, most of which provide broader exposure to the Chinese equity markets than does FXI.
The biggest issue with FXI is one of scope. It's strictly a large-cap fund that holds only 25 names traded in Hong Kong, most of which are state-owned financial, energy and telecom companies.
But the real roadblock here is that it's only eligible to hold H-shares and red chips.
This means FXI misses out on Chinese mega-cap P-chips, like Hong Kong-listed Tencent Holdings, and U.S.-listed N-shares like Baidu (although starting March 2013, FXI will be eligible to hold P-chips due to a recent FTSE reclassification of P-chips).
I do want to make it clear that FXI is not a bad fund.
It does what it's supposed to do-that is, track the FTSE China 25 Index. For institutions concerned about liquidity, FXI is also a no-brainer-the fund is a liquidity beast, trading on average, almost $600 million a day and over 100 creation units.
But for retail investors looking for the broadest exposure to Chinese equities, a fund like the SPDR S&P China ETF (NYSEArca:GXC) makes more sense. While GXC has over 200 holdings across all cap-sizes, the real key here is that it's eligible to hold all investable Chinese shares.
To me, GXC is the current the SPDR S&P 500 ETF (NYSEArca:SPY) of China ETFs. Meanwhile, I'm not even sure I would consider FXI to be the equivalent of the SPDR Dow Jones Industrial Average Trust (NYSEArca:DIA).
In the coming years, as China continues to open its markets, I expect newer and even more comprehensive China ETFs to launch from various issuers. If there's one market out there that investors should keep an open mind on, it's China.
So, investors should stay tuned.
Moving on from China, I want to focus on Japan and EWJ.
Now that the yen is getting pummeled and the Nikkei is flying, it seems Japan has gone from being the most hated dog to the coolest kid in the investment world.
In just a couple of months, investors have suddenly turned bullish on Japan in a hurry on expectations that the new prime minister Abe's aggressive policies to battle deflation will lead to more yen weakness, and spur a rally in Japanese stocks.
To that point, it seems U.S. investors are now really catching on to the benefits of being currency-hedged in the current environment in Japan.
Since the beginning of December, the WisdomTree Japan Hedged Equity Fund (NYSEArca:DXJ) has had inflows of over $320 million, helping it catapult over the $1 billion mark in assets under management.
While EWJ had inflows of around $110 million during that same time, I'm still baffled that EWJ remains a $4.7 billion fund, especially after the yen was hovering in the 78-80 yen/dollar range for the five months prior to the latest rout that began in November.
Without a currency hedge, investors in EWJ are taking a direct hit as the yen gets pummeled. As an example, let's assume that Abe is successful in his currency-weakening agenda and the yen weakens to 100 yen/dollar-which would be a 17 percent drop from current values.
Now, even if Japanese equities didn't budge over the same period, that would still be a 17 percent loss in returns for EWJ.
By the way, in this example, I'm assuming all its holdings are priced and traded in yen and, as of Dec. 21, 2012, all EWJ's holdings were traded on the Tokyo Stock Exchange, Osaka Stock Exchange, or the Jasdaq.
Again, EWJ is not a bad fund. It does what it's supposed to do, which is to track the non-currency hedged MSCI Japan Index. And of course, the opposite is true here as well. If the yen surges, EWJ would be fully exposed to those yen gains.
But rather than speculate whether the yen will continue to weaken or not, a better question to ask is:Does anyone think that the Nikkei and Japanese equities will continue to perform well if the yen surges back to 75 yen/dollar and beyond?
If you really think that Japan becomes the new cool for 2013 based on the notion that the yen will continue its depreciation, then EWJ still looks overrated compared to DXJ.
At the time this article was written, the author held a long position in DXJ. Contact Dennis Hudachek at email@example.com.
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