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Three ways to invest in large-caps in Japan with ETFs

Japan economy - significant and competitive
Mount Fuji

With the third largest economy in the world, and a stock market that ranks amongst the largest in the world, Japan is an important market for investors. Its domestic economy may have its challenges, but Japan is still home to numerous important global industrial and consumer companies, including Toyota, Mitsubishi, Sony and Softbank. In recent years, Japan’s stock market has recorded lower volatility than some other Asian markets, providing investors with diversification within Asia.

Japanese large caps can therefore offer investors an important tool to diversify portfolios. There are several approaches that can be followed to invest passively in Japanese large caps by tracking a range of indices. The following ETFs managed by ComStage, Backrock and Ossiam are three options to consider. These three Japan ETFs are all accumulating-funds and dividends are reinvested.

ComStage Nikkei 225 Japan ETF (EUR)

The ComStage ETF (ISIN: LU0378453376) tracks the well-known Nikkei 225 index. This index is price weighted index, which many consider an arbitrary way to allocate capital. Nevertheless, it is still the most widely followed benchmark for Japanese equities.

The Nikkei 225 index tracks the largest 225 equities listed in Japan. The result of the weighting methodology is that the fund’s largest holdings include relatively obscure companies like Fast Retailing and Fanuc Corp. However, it is worth noting that only 24 counters have an index weight of more than 1%, so apart from a few large holdings, the bulk of the index is well diversified.

In terms of sector weightings, 21% of the fund is invested in consumer discretionary stocks and just less than 20% is invested in industrials. IT, consumer staple, healthcare and communication stocks make up the bulk of the remainder of the fund.

How well did the Nikkei Japan ETF Perform?

The fund lost 4.96% during the 2018 calendar year and returned 5% and 13.7% respectively for the two- and three-year periods to December 2018. In January 2019 the fund returned 5.52%. The three-year trailing Sharpe ratio to the end of January 2019 was 0.85.

The ComStage ETF has an annual management fee of 0.25% which is relatively low for Japanese large cap ETFs.

iShares Core MSCI Japan ETF (EUR)

Blackrock’s Core MSCI IMI ETF (ISIN: IE00B4L5YX21) tracks the MSCI Japan index which is weighted according to the free-float adjusted market capitalization of securities. The indexing methodology focuses on invest-ability by removing crossholdings from the market value of a company. The index includes 1,287 securities making this the broadest of the three funds.

The largest individual holding includes Toyota Motor Corp (3.46%), SoftBank Group Corp (1.90%) and Mitsubishi UFJ (1.56%). The largest 10 holding make up 15.6% of the fund, and only 9 stocks have a weighting of more than 1%.

This fund has a slightly lower allocation to consumer discretionary stocks, and a higher weighting in the financial services sector. Apart from those differences, the MSCI index sector composition is very similar to the Nikkei 225 index.

Did diversification help performance for this Japan ETF?

The fund lost 10.43% during the 2018 calendar year and returned 0.4% and 7.11% respectively for the two- and three-year periods to December 2018. In January 2019 the fund returned 6.64%. The three-year trailing Sharpe ratio at the end of January 2019 was 0.67.

Blackrock’s ETF has an annual management fee of 0.2% which is amongst the lowest for comparable funds.

Ossiam Minimum Variance Japan ETF (EUR)

The Ossiam Japan Minimum Variance ETF (ISIN: LU1254453738), and the index it tracks, selects constituents of the S&P TOPIX 150 Index that display the lowest price variance. The fund currently holds 76 securities and is rebalanced monthly.

The largest holdings include Nitori Holdings (3.96%), Mizuho Financial Group Inc (3.39%), Mitsubishi Heavy Industries Ltd (3.03%) and Japan Airlines Co Ltd (2.93%). This fund is more concentrated than the other two, resulting in the largest 10 holding making up just under 30% of the fund.

The most notable differences between this fund and the BlackRock and ComStage funds is a higher allocation to the consumer defensive, utility and healthcare sectors. Allocations to basic materials and technology are also noticeably lower.

Does the minimum variance strategy work for this Japan ETF?

The fund lost 5.51% during the 2018 calendar year and returned 8.84% for the two-year period to December 2018. In January 2019 the fund returned 5.94%. This ETF has not yet achieved a three-year track record but has outperformed the other two funds over two years.

The Ossiam ETF is a more specialised ETF and has a significantly higher annual management fee of 0.65%. It should also be noted that the index methodology results in higher turnover than market cap weighted funds.

Conclusion

In recent years the larger number of stocks in the Japan MSCI index has resulted in persistent, though slight, underperformance versus the Nikkei 225 index which is price weighted.

The Ossiam Minimum Variance fund doesn’t yet have a long enough track record to be properly compared over longer periods. However, over the past two years it has outperformed both the ComStage and BlackRock ETFs in terms of return and on a risk adjusted basis. It is substantially more expensive, but, if the performance can be maintained the fees would be justified.