After pulling back in late 2015 and early 2016, the Nikkei 225 has resumed the bullish rise that began four years ago in response to what has been called “Abenomics.” Named in honor of Japanese Prime Minister Shinz? Abe, the economic policies that he advocates are based on “three arrows” of structural reform, fiscal stimulus and monetary easing aimed at spurring the Japanese economy, boosting gross domestic product (GDP) and increasing the nation’s exports.
Nearly all of the world’s central banks have engaged in some form of extraordinary monetary policy since the global financial crisis, although the measures instituted by the Bank of Japan (BoJ) have been the most aggressive by far. While the BoJ has signaled that it will begin to tighten monetary policy and taper its bond purchases, the central bank will continue to expand the country’s monetary base until inflation reaches the 2 percent target by pinning the yield on the benchmark 10-year government bond at zero percent.
The postelection U.S. dollar rally has significantly weakened the yen. Prudent investors expect the yen’s infirmity to persist in light of Japan’s overwhelming government debt and the deflationary effects of a stronger U.S. dollar. WisdomTree’s Japan Hedged Equity Fund (DXJ) is well-positioned for such climates and should be considered by those who are bullish on Japanese stocks and bearish on the yen.
Fund Overview
This exchange-traded fund (ETF) seeks to track the returns of WisdomTree’s Japan Hedged Equity Index. Generally, 95 percent of the passively managed fund’s $7.1 billion in assets under management (AUM) will be invested in components of the index or other investments that have substantially identical economic characteristics. The index is designed to neutralize fluctuations between the yen and the dollar while providing exposure to Japanese equity markets.
Investment Strategy
DXJ is slanted toward dividend-paying companies incorporated in Japan that have an export tilt and are listed on the Tokyo Stock Exchange. The companies need to derive less than 80 percent of their revenues from inside Japan. Thus, holdings typically have greater exposure to fluctuations in world currencies and may decline when the yen appreciates. Selection criteria include paying at least $5 million in annual cash dividends, a market capitalization of at least $100 million and an average daily trading volume of $100,000. The index is dividend-weighted and rebalanced annually. While the maximum exposure to a single company is capped at 5 percent, a sector weighting cannot exceed 25 percent. The ETF enters into forward currency and futures contracts designed to offset the portfolio’s total exposure to the yen.
Portfolio Composition and Holdings
With an average market cap of $18 billion, which is slightly lower than the underlying index, the portfolio has a 59.16 percent exposure to giant-cap shares and a 25.86 and 12.11 percent exposure to large- and mid-cap stocks, respectively. The ETF also has a 2.8 percent investment in small-caps and negligible exposure to micro-cap shares. In addition to a P/E ratio of 13.16, the ETF has a price-to-book ratio of 0.92. The fund is overweight basic materials, consumer cyclical and financial services sectors while underweight communication services, consumer defensive and technology shares. The top 10 holdings account for approximately 32 percent of AUM. In descending order, they are Toyota, Mitsubishi UFJ Financial, Sumitomo, Mizuho Financial and Japan Tobacco, followed by Canon, Nissan, Honda, Takeda Pharmaceutical and Mitsui.
Historical Performance, Risk and Fees
Featuring a Morningstar average return rating, DXJ has delivered total one-, three- and five-year returns of -8.06, 4.79 and 13.35 percent, respectively. These compare with the Japanese stock category averages of -3.28, 4.69 and 9.87 percent, respectively, over the same periods. The ETF has a three-year beta of 0.94 and a standard deviation of 19.27. The category averages are 0.76 and 14.04, respectively. DXJ has an expense ratio of 0.48 percent.
DXJ is suitable for investors with a well-balanced core portfolio who are looking for additional hedged exposure to Japanese equities. This popular ETF is positioned to benefit from the increased economic activity in Japan spurred on by Abenomics and the weakening of the yen versus the U.S. dollar. DXJ is one of the most liquid funds in the segment. An alternative investment for investors is the iShares Currency Hedged MSCI Japan Fund (HEWJ). This ETF invests in iShares MSCI Japan (EWJ) and adds a currency hedge. For investors who still want a passive index approach, this fund has sufficient volume and charges the same fees as DXJ. We prefer DXJ because it focuses on dividend payers and tilts the portfolio in favor of exporters who will benefit from a weaker yen.
We have raised our recommendation for DXJ to a Strong Buy with a ranking of 87.