Market Overview

Play The Japan Rally With These ETFs

Play The Japan Rally With These ETFs

The Nikkei 225, Japan's benchmark equity index, has surged almost nine percent in the past month as investors have bought into the notion that newly elected Prime Minister Shinzo Abe could actually prove successful in weakening the yen.

The yen, already on pace to be the worst-performing developed market currency in the world this year, is hovering near 21-month lows against the dollar and multi-month lows against the euro, Australian dollar and other major currencies as Abe continues to sharpen his currency-weakening rhetoric. A cornerstone of his campaign, Abe has demanded that the Bank of Japan engage in unlimited monetary easing and target inflation of two percent, double the central bank's current goal.

Showing he is not one to pull any punches, Abe has said that if BoJ does not get in line with his easing and inflation demands, he will work to revoke a Japanese law guaranteeing the central bank's independence. Abe has also threatened to remove BoJ governors that do not see things his way.

The headlines are a welcome respite from nearly two decades of spiraling equity prices, deflation, rising deficits and assorted other black marks that have plagued Japan, the world's third-largest economy. Since its debut in April 1996, the iShares MSCI Japan Index Fund (NYSE: EWJ) has lost almost 41 percent, painting the picture of just how perilous investing in Japan has been.

With that type of savage decline in mind, it is understandable that some investors will take a "show me" attitude when it comes to Japan. It is logical to ask how and why things will be different under Abe this time around (this is his second go round as Japan's prime minister). Assuming Abe is successful in restoring lost glory to Japan's economy, these are the ETFs with which to play that theme.

Precidian MAXIS Nikkei 225 Index ETF (NYSE: NKY) Most ETF industry observers would say it is hard for a firm to be successful with just one fund on the market, but the MAXIS Nikkei 225 Index ETF has proven to be a success for Precidian as the fund just crossed the $200 million in assets under management mark.

NKY is an easy to comprehend ETF. What this fund amounts to is a tracking ETF for the Nikkei 225. That means with a 24.4 percent weight to industrial firms and a 15.4 allocation to technology companies, NKY is heavily exposed to Japanese exporters. Should Abe's yen-weakening efforts prove fruitful, NKY will be one of the more desirable destinations among Japan ETFs.

Investors should note that NKY is not perfect in terms of tracking the Nikkei 225. For example, since Abe won on December 16, the Nikkei 225 is up about 4.1 percent while NKY has added about 2.5 percent. On the other hand, it is worth noting that NKY has gained 11.3 percent in the past year compared to an 8.5 percent jump for EWJ.

SPDR Russell/Nomura PRIME Japan ETF (NYSE: JPP) Due to the fact that is has just $14.55 million in AUM and average daily volume of just 3,200 shares, the SPDR Russell/Nomura PRIME Japan ETF is likely to turn off lovers of superficial ETF metrics. Still, there is no getting around the fact that the fund is up 5.4 percent in the past month.

JPP employs what is known as a sampling strategy. That means the ETF is not home to every stock in its underlying index. In this case, JPP is home to 391 of its index's 1,000 components and its overall lineup is very similar to EWJ's.

Industrial and technology names combine for 34 percent of JPP's weight and Japanese auto giants Toyota (NYSE: TM), Mitsubishi and Honda (NYSE: HMC) are JPP's top three holdings. Combine that with the fact that JPP does not offer a currency hedge and JPP is another fund could build on recent gains if Abe is successful in suppressing the yen's upside.

WisdomTree Japan Hedged Equity Fund (NYSE: DXJ) Speaking of yen hedges, the WisdomTree Japan Hedged Equity Fund does offer a hedge on USD/JPY fluctuations, but that has not held the ETF as the yen has plunged in recent weeks. Quite the opposite is true as DXJ has surged 8.83 percent in the past month. Said another way, DXJ has outperformed the ProShares UltraShort Yen (NYSE: YCS), a double-leveraged play on the yen against the dollar.

Earlier this month, DXJ's underlying index began employing a geographic filter designed to remove companies that derive the bulk of their revenue from Japan. Interestingly, DXJ was already on the move higher before that filter was introduced. Over the past 90 days, DXJ has jumped 14.5 percent.

To put that move into context, combing the returns offered by the major South Korea and Thailand ETFs over the same time horizon would still result in a number that lags DXJ's returns.

Bottom line: DXJ is attractive because Japanese firms that are heavily dependent on their home nation to drive top-line growth, particularly if they run capital-intensive businesses that used imported raw materials. A weaker yen is good Japan's exporters, not so much for the importers, and DXJ capitalizes on that theme.

For more on Japan and ETFs, click here.


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