Japan ETFs In Focus After Devastating Quake

by on March 14, 2011 | ETFs Mentioned:

The attention of investors shifted from the Middle East to Japan late last week, as the natural devastation caused by a massive earthquake trumped the manmade chaos that has been playing out in Libya, Saudi Arabia, and elsewhere in the oil-rich region. With rescue efforts intensifying in the north of Japan after a magnitude 8.9 quake and resulting tsunami, a potential nuclear crisis has emerged as another threat that could impact the entire country. The death toll had climbed to nearly 1,600 on Sunday, but by some estimates that figure will reach as high as 10,000 as rescue efforts continue.

Assessing the economic impact remains challenging as details continue to emerge, though investors have been selling off Japanese stocks since the quake hit and are expected to continue to do so when trading resumes on Monday. The area closest to the epicenter of the quake accounts directly for only a small portion of Japanese GDP. Still, the ripples from the disaster began to spread over the weekend, with expectations over the economic toll of the natural disaster varying considerably. Many production facilities had already been shut down, and rolling blackouts were expected to occur for the next several days.

Bank of Japan Governor Masaaki Shirakawa told reporters on Sunday that the central bank would consider the impact of the earthquake when it meets for a rate review on Monday, an event that will no doubt be watched closely by investors around the globe. Some analysts believe the earthquake will bring already slow economic growth to a halt or push the Japanese economy into contraction during the next two quarters, before reconstruction spending provides a boost. Delivering an economic recovery from the disaster is complicated somewhat by Japan’s massive debt burden, which currently stands at more than 200% of GDP [see Three Country ETFs With Low Debt-To-GDP].

Japan ETF Options

For investors interested in exposure–both long and short–to Japanese equities, there are a number of options–seven different fund in the Japan Equities ETFdb Category to be exact.

Is should be noted that the timing of the catastrophe resulted in some significant discounts among these products. The earthquake hit towards the end of Friday trading on the Tokyo Stock Exchange, and many investors didn’t have an opportunity to sell off shares before the closing bell. Because the earthquake hit hours before U.S. markets opened, Japan ETFs were extremely active in Friday trading, with sharp sell-offs occurring as more information on the extent of the damage and additional risk factors became known. EWJ closed Friday at a premium of more than 2% to its NAV, reflecting not a lack of liquidity in the fund–more than 60 million shares traded hands–but a nuance of international ETF investing. While trading in the underlying securities has halted for the weekend, Japan ETFs effectively acted as price discovery mechanisms that reflected the latest news on the impact of the quake.

Large Cap ETFs

By far the largest and most heavily-traded ETF is the iShares MSCI Japan Index Fund (EWJ), a product that invests in more than 300 Japanese equities. The top holdings of EWJ include several well-known firms headquartered in Japan but generating revenue throughout the world, such as Toyota, Honda, Mitsubishi, Canon, and Sony. From a market cap perspective, EWJ is dominated by giant and large cap companies, which make up about 85% of total holdings.

Other ETFs consisting primarily of large cap Japanese stocks include the iShares S&P/TOPIX 150 Index (ITF) and SPDR Russell/Nomura PRIME Japan ETF (JPP).

Small Cap Japan ETFs

Some investors prefer to achieve access to international markets through small cap stocks, viewing these securities as more “pure plays” on the local economies that reflect domestic consumption patterns more closely that their large cap counterparts. For investors looking to bet on small cap Japanese stocks, there are three different ETF options [use the ETF screener to find all options for international small cap exposure]:

  • iShares MSCI Japan Small Cap Index Fund (SCJ)
  • WisdomTree Japan SmallCap Dividend Fund (DFJ)
  • SPDR Russell/Nomura Small Cap Japan ETF (JSC)

Hedged Equity ETF

Most international equity ETFs expose investors not only to stocks listed in a particular country or region, but also to exchange rate fluctuations–a risk factor that can often have a much more significant impact on bottom line returns than investors realize [see For ETF Investors, The Details Matter]. There are, however, a couple of international equity ETFs that hedge out exchange rate risk, including the increasingly-popular WisdomTree Japan Hedged Equity Fund (DXJ). For investors looking to access Japanese equities but avoid any risk associated with movements in the JPY/USD exchange rate, this ETF can be an interesting play.

Japanese Yen ETFs

There are, of course, also ETF options for investors seeking to access only the value of the yen relative to the U.S. dollar. TheĀ  Japanese currency actually jumped after the quake, a movement that may seem counter-intuitive but that has historically played out in the aftermath of natural disasters. Expectations for repatriation of funds by insurers and Japanese companies drove the yen initially higher, and in coming weeks investors will be watching closely for evidence that this cross-border is actually occurring. Based on those results, as well as decisions by Japan’s central bank in the week ahead, the yen could be rather volatile. Currently, options for accessing the yen through an ETF include:

  • iPath JPY/USD Exchange Rate ETN (JYN)
  • WisdomTree Dreyfus Japanese Yen Fund (JYF)
  • CurrencyShares Japanese Yen Trust (FXY)

There are also two options for leveraged exposure to the yen, including the ProShares UltraShort Yen (YCS) and Ultra Yen (YCL).

Japan Bond ETFs

There aren’t any pure play Japanese bond ETFs available to U.S. investors–at least not yet–but Japanese debt makes up a significant portion of many of the funds in the International Government Bonds ETFdb Category. Japanese debt accounts for about 23% of the portfolio of the SPDR Barclays Capital International Treasury Bond ETF (BWX).

Disclosure: No positions at time of writing.