The first two months of the year saw total net inflows to Japan-listed exchange traded funds and exchange traded products hit a record $9.24bn, according to data from consultancy ETFGI. However, while these domestically listed ETFs/ETPs have gathered record flows, ETFs providing exposure to Japan itself have fared less well with foreign investors withdrawing money.
ETF Strategy reviews the different exposures to Japanese equities
Japan presents a mixed bag for investors. This year the Nikkei 225 (the most widely quoted average of Japanese equities) has performed badly. On 6th April the index dropped nearly 15% from its start of the year high of 18,450.98 points, but this was still not as low as its close on 12th February of 14,952.61 points.
This poor performance prompted foreign investors to pull money out of Japanese equities. Data from iShares shows that this year-to-April foreign investors have pulled some $8bn out of Japanese equity ETPs. However, this was a markedly different picture to that of Japanese domestic investors – which include institutional investors, Bank of Japan and private investors – who have bought about $14bn worth of Japanese equities.
According to Wei Li, Director, head of EMEA investment strategy for iShares, Japanese equities are among the best valued in the developed world, even when compared to European equities which also offer reasonable value. “One reason for such attractive valuation is YTD performance – Japanese equities are amongst the worst performing country equities, as opposed to being flat like the US or up, like the FTSE. This is despite best efforts from BoJ, performance flows from domestic investors and a positive corporate cultural shift.”
She adds: “It makes sense to view Japanese equities long term because there are corporate cultural shifts that warrant a closer look. For example, companies are now engaging in shareholder rewarding. E.g. dividend payback, share buyback schemes, etc. and it is foreseeable that Japanese companies that engage in such practices could be rewarded in the long term.
For investors wanting to take a long term view on the positive cultural shifts taking place in Japan there are indices that make this possible. The JPX-Nikkei 400 index has a quality filter on companies such as return on equity.
“In some cases it has been viewed as a badge of honour for companies to be included in this. This is an example that reflects this cultural shift, which is why you have the BoJ buying Nikkei 400 ETFs,” says Li.
The only exposure to get through iShares to the JPX-Nikkei 400 is its iShares JPX-Nikkei 400 EUR Hedged UCITS ETF. The (NK4E) ETF, which hedges again the Yen, costs 0.25% and has returned -9.29% YTD.
The Bank of Japan and the government show a close interest in the ETF market. The BoJ buys ETFs as part of its QE programme and is even looking to launch certain ETFs with specific exposure to Japan, which is all supportive of a favourable Japanese investment opportunity.
Last month the BoJ announced it would not be introducing further monetary stimulus.
Jesper Koll, CEO of WisdomTree Japan, said: “The decision to hold fire was more conservative than many market participants had wished for but this is by no means a failure of Abenomics. Rather, this is about the BoJ taking a calm and measured approach to monetary policy, having already introduced negative rates in January.”
While this move didn’t unsettle the Nikkei 225 too much it failed to impact the significant headwinds facing Japan in the aftermath of the initial euphoria from Abenomics and strengthening of the Yen.
Chanchal Samadder, Head of UK and Ireland ETF Sales at Lyxor, adds that despite recent weakness in fundamentals and growing negative sentiment towards the long term effectiveness of Abenomics, Japanese equities continue to trade at undemanding valuations. “We see fiscal policy as the main driving force of growth for Japan, along with possible further interventions by the BoJ…. We believe that Abenonomics and the wider Japanese fiscal and monetary stimulus will support Japanese equities in the long term. We have seen the full spectrum of investor using our Topix and JPX Nikkei ETFs, ranging from institutions to IFAs.”
Samadder explains the provider also has a positive view on the BoJ buying ETFs: “Firstly for the equity markets, but also as a stamp of approval for ETFs as an investment vehicle.
“The creation of the JPX-Nikkei 400 index and its backing by the GPIF and BoJ suggest there is a structural shift in investor sentiment towards corporate governance.”
Flows into the Lyxor JPX-Nikkei 400 (DR) UCITS ETF continue to be positive in 2016.
Other market watchers are also positive on Japan.
Chris Mellor, head of equity product management at Source, adds: “Japan is early in its economic cycle, which is unlike the US. In Japan you are also plugged into Abenomics, which was behind a helpful central bank policy for growth and recovery.”
Mellor explains that the Source JPX-Nikkei 400 UCITS ETF is an ETF designed to encourage good corporate behaviour, shareholder value and productivity. “It sits in the smart beta realm and has filtering on certain aspects. In particular, filtering at a board level – depending on how many external board members a company has. It also looks at report accounting and whether this is done in Japanese only or Japanese and English – which is deemed how accessible the company is. Then there is a filter on whether the company is registered for IFRS accountancy standards,” he explains.
The ETF costs 0.25% and trades in either USD or GBP. It provides access to the performance of the JPX-Nikkei 400 Net Total Return Index, after fees. However, there are risks with this ETF; there is no capital protection, swaps are also used (the ETF is synthetic) which means the investors is exposed to counterparty risk, and there are also changes in the currency rate between base currency and trading currency.
An alternative to this is to invest through a domestic manager which can help reduce costs and add better trading.
Japanese asset manager Nikko AM has an office in London which investors can use to access the market through Japan-listed ETFs. The firm offers the Listed Index Fund JPX Nikkei Index 400, which has US $549m in assets and costs around 0.15%.
Geoff Post, head of international product development at Nikko AM, said: “We are able to more efficiently execute trades and keep costs down because we trade when Japan is open, not when it is closed, which we see European-listed ETFs do. It means we get the benefits of lower spread, lower price volatility and better tracking.”
Post explains that Nikko AM has a specific type of offering on Japan, which is different to European listed ETFs. “This and the regulatory environment means the investors who do business with us are generally asset allocators with multi asset roles in investment management companies and European pension funds. If they [investors] have a certain conviction and need an efficient way of executing this view, they come to us.
“Our market view is that we are positive on individual companies in Japan, where we manage active funds and we take a bottom up approach when we look at them. We believe that the quality of management in companies in Japan continues to increase and the corporate governance is improving,” says Post.
Alternatively, the TOPIX has been making a comeback, according to Lyxor’s Samadder. “The interesting trend has been the renewed interest in the TOPIX Index due to its greater exposure to mid and small cap domestic companies, which are typically less exposed to the stronger Yen,” said Samadder.
The Lyxor Japan (TOPIX) (DR) UCITS ETF D-EUR (GBP) [JPNL] replicates movements in the TOPIX Gross Total Return index, which is then converted into euro while minimizing as far as possible the tracking error between the Fund’s performance and that of the TOPIX Gross Total Return index. It has an ongoing charge of 0.45%.