ETF Spotlight: Japan Interest Rate Strategy Fund (JGBB)

Published on by on October 1, 2014

The ETF universe has grown by leaps and bounds in recent years as issuers continue to roll out investment vehicles for investors of all types. When it comes time to finding the right product for your portfolio, having too many choices at your fingertips can make the security-selection process all the more intimidating; with over 1,600 ETFs on the market, finding one that best suits your objectives isn’t always as straightforward as it may seem [try our Free ETF Screener]. 

In an effort to shed more light on some of the products out there that are flying under the radar for many investors, below we’ll take a deeper dive into a unique fund: the Japan Interest Rate Strategy Fund (JGBB) from WisdomTree

Inside JGBB’s Investment Strategy

Japan's population will decline in the coming years, is that really a bad thing?The Japan Interest Rate Strategy Fund bears a name that isn’t very revealing in the sense that it might not be very obvious what this ETF does at first glance. This ETF falls under the Long-Short Category of products, which means that it employs a strategy that differs greatly from a traditional, “plain vanilla,” long-only equity fund.

Instead, JGBB takes both long and short positions; specifically, its underlying index consists of three components. First, the ETF holds a long position in U.S. Treasury Bills with maturities of one to three months. Second, the ETF holds a short position in Japanese Government Bonds, or JGBs, with maturities between five and 10 years. Lastly, JGBB is currency-hedged, which means that it takes a long position in the U.S. dollar relative to the Japanese yen [see Foreign Currency Risk 101: What Investors Need to Know]. 

Now let’s put this investment strategy into perspective. JGBB is essentially designed to take advantage of a decline in JGBs as well as the yen, relative to the performance of U.S. T-Bills and the dollar respectively. In other words, JGBB can be expected to rise and generate a profit so long as Japanese Government Bonds (JGBs) decline in value, given that it maintains short exposure to this asset class. 

Under the Hood of JGBB

JGBB’s underlying portfolio of holdings consists primarily of debt securities. The long component is made up of U.S. T-Bills maturing in one to three months; furthermore, allocations to these securities are weighted by market capitalization and are rebalanced every month. The ETF’s short component is made up of short positions on JGBs maturing in five to 10 years; it too is market cap weighted and rebalanced on a monthly basis [see also 25 Unique ETFs You May Have Missed]. 

The third component, which aims to serve as a currency adjustment, is made up of a long position in the U.S. dollar and a short position in the yen; more specifically, the short yen exposure is expected to be about 30% of the fund’s total portfolio value and adjusted on a yearly basis. This means that if JGBs remain unchanged while the yen declines, this ETF can still be expected to generate a positive return given its net short exposure to the yen relative to the U.S. dollar. Likewise, this ETF can be expected to perform poorly, or generate a negative return, if JGBs appreciate in value. 

Other Considerations

JGBB is essentially a “short JGBs” fund because although it’s structured as a long-short product, it’s long component is parked in ultra-short duration Treasury Bills, which can be expected to behave like cash. In other words, the vast majority of this ETF’s price movement can be expected to come from its short component and fluctuations in the value of JGBs, since its long component, which is essentially comparable to a cash position, isn’t going to fluctuate in value nearly as much (if at all). 

Also, because this ETF features a long-dollar and short-yen component, it’s essentially a tool designed to bet against the decline of Japanese government bonds as well as the nation’s currency [see also ETFdb's King Dollar Portfolio]. 

How to Use JGBB in a Portfoliophotodune-535754-analyzing-data-on-computer-xs

JGBB is perhaps best characterized as a tactical tool given its rather focused strategy. This ETF is essentially designed to bet against JGBs, which makes it appealing in small doses; that is to say, for most investors, making a major allocation to such a targeted product would be less-than-ideal unless you have extremely strong conviction that JGBs are destined to sink. 

While not a major sticking point, this ETF is also a bit expensive to be considered a “core” holding, especially among cost-conscious investors. JGBB boasts a 0.50% expense ratio, which is on the low end of the cost spectrum among Long-Short ETFs; however, this is still a steep price to pay if you intend to make a major allocation to it over the long-haul. 

Perhaps the best use of JGBB is as a targeted trading vehicle; that is to say, those who are bearish on JGBs can really take advantage of this ETF as it offers a convenient way to execute a trading strategy that would otherwise be too costly and difficult to maintain on an ongoing basis. 

The Bottom Line

JGBB is a one-of-a-kind ETF that warrants a closer look from anyone looking to take advantage of the current environment in Japan; if you’re looking to bet that Japanese monetary policy will lead to a substantial decline in JGBs, and a spike in JGB yields, then this is an ETF that you should strongly consider. As always, be sure to take a good look under the hood and understand all of the risks and nuances associated with any one product before making an allocation.

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Disclosure: No positions at time of writing.