In Part 1 of this series we looked at Japanese equities with a positive growth story, specifically Abenomics, how the BoJ has influenced ETF buying in Japan and ways to invest in the increased corporate governance of companies in Japan. In this article we will look at Yen weakening and whether there is still a need to hedge when getting exposure to the region.
Japan and global growth
Not everyone has a positive view on Japan. Those who believe global growth will continue and the Yen will weaken can get exposure through companies in Japan where a large part of their exposure comes from foreign revenue.
The Source STOXX Japan Exporters UCITS ETF (JPEX), which has an annual fee of 0.35% and is also available in a currency hedged version. The ETF sits in the smart beta space and gives investors the chance to take a view on Japanese growth and currency differentials.
Source’s Mellor, said: “It is based on companies in Japan where more than 50% of exposure is from foreign revenue. It is good when global growth is stronger than domestic growth but also gives exposure to changes in the exchange rate. It performs well if the Yen is weak, but underperforms if the Yen is strong or when the Yen is a safe haven as we have seen in the first two months of this year. There is data since 2007 over times of currency weakness and of these six times the Exporters outperformed five times.”
Another option is the WisdomTree Japan Equity UCITS ETF [DXJZ/DXJG], available to trade in US dollar or sterling, costs 0.40% and has $34m in AUM. It tracks the WisdomTree Japan Equity Index, which consists of dividend-paying companies that are incorporated in Japan, are traded on the Tokyo Stock Exchange and which derive less than 80% of their revenue from sources in Japan. By excluding companies that derive 80% or more of their revenue from Japan, the Index is tilted towards companies with a more significant global revenue base. The companies included in the Index typically have greater exposure to the value of global currencies.
The provider’s sister ETF from the US is the WisdomTree Japan Hedged Equity ETF (DXJ) tracks an exporter-focused, dividend-weighted index of Japanese stocks. The fund is hedged for currency fluctuations between the US dollar and Japanese yen.
Hedging
The Yen operates as a safe haven currency during times of market uncertainty and because of the export-oriented nature of the economy, is negatively correlated to Japanese equities. It has strengthened over the past few months, which makes a negative case for Japanese equities.
For a domestic firm like Nikko AM, where the business is primarily orientated around the Japanese institutional investors and the product range reflects this, there are no questions about hedging because all its Japanese ETFs are Yen denominated. “Our products are largely plain vanilla ETFs on the Nikkei 250 and the TOPIX 400, which echoes the demand from Japanese institutional investors,” says Post.
“The recent market environment has seen a rally in the Yen, which is seen as a safe haven asset. As a result we have seen some investors switch from hedged to unhedged positions. Lyxor’s hedged (USD, GBP, EUR, CHF) and unhedged share classes share the same fee of 0.25% so the decision is purely driven by their view to currencies,” said Samadder.
iShares’ Li explains that the strong Yen is combined with a dovish Fed, who make comments that impact the Yen currency more than the rate cut from the BoJ. “The BoJ has not done much since rate cut, probably wanting to keep its powder dry and wait for the Fed to play out.”
The iShares MSCI Japan GBP hedged UCITS ETF (IJPH) costs 0.64% and has £326m in AUM. It tracks the performance of an index composed of Japanese companies which also hedges JPY currency in the index back to GBP on a monthly basis. Launched in July 2012, total return is currently down 9.31% YTD. This compares with the non-hedged version – the iShares MSCI Japan UCITS ETF (Dist) (IJPN) – where the total return YTD is only down 1.37%. The fund, which tracks the performance of an index composed of Japanese companies, was launched in October 2004, has $2.6bn in AUM and costs 0.59%.
This means that there are different questions to ask when investing in Japanese equities – primarily whether to hedge or not.
Li says: “In previous years international investors have considered hedged Japanese equities, but now that the Yen has been strengthening and international investors have been selling their hedge equity positions. It is also worth noting that from an international investor’s perspective, an unhedged Japanese equity portfolio has tended to be less volatile than a hedged Japanese equity portfolio because Japanese equities and the yen are negatively correlated. Managers are going to have to be mindful of this and perhaps consider a mix of hedged and unhedged equities.”