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IndexIQ, the firm behind a suite of hedge fund replication ETFs and small-cap country-specific funds, notched another first for the ETF industry on Thursday. The IQ Japan Mid Cap ETF (RSUN) will seek to replicate an index that consists of about 100 mid-cap Japanese stocks. The weighted average market capitalization of the companies that make up the index will be approximately $3 billion.

RSUN is the ninth ETF in the Japan Equities ETFdb Category, and the first to focus exclusively on mid-cap stocks. RSUN will offer a tool for establishing complementary exposure to large-cap Japan ETFs (such as EWJ) and small-cap funds (including SCJ, JSC and DFJ). In recent years, investors have embraced small-cap and mid-cap equities as a means of establishing more “pure play” exposure to international markets. Whereas funds dominated by large caps tend to include multi-national firms that generate revenue around the globe (EWJ’s top holdings include Toyota (NYSE:TM), Honda (NYSE:HMC) and Mitsubishi (OTC:MIELF)), small-cap and mid-cap stocks will generally be more dependent on changes in local consumption. “Japan has seen more than its share of tragedy this year, yet the country is remarkably resilient with a strong global economic base supported domestically by many leading small- and mid-cap companies,” said Adam Patti, CEO of IndexIQ. “To date, there has been no way for individuals in the U.S. to get focused exposure to the potential of these mid-sized companies. RSUN allows investors to isolate and access this sector of the Japanese economy in a low cost, highly liquid, tax efficient way.”

Under the Hood

Mid-cap ETFs also generally offer unique sector exposure from both their large-cap and small-cap counterparts. RSUN’s biggest allocations are to industrials (23%), financials (18%) and consumer discretionary stocks (16%). Utilities (2%) and energy (1%) make up some of the smallest sector weightings. Exposure is spread relatively evenly across the portfolio; none of the 100 components make up more than 2% of total assets, avoiding concentration issues that can be significant in some international ETFs.

The relatively heavy allocation to materials and industrials stocks may make RSUN an interesting option for those looking to gain exposure to corners of the Japanese market that may thrive as the rebuilding efforts continue. These two sectors account for about 39% of RSUN holdings. RSUN may also be appealing to those looking for attractively-priced Japan exposure; the P/E and P/B ratios of RSUN are considerably lower than many large-cap Japanese ETFs.

Japan Economy: At a Crossroads

The launch of RSUN comes at an interesting time for the Japanese economy. Through recently surpassed by China in terms of total GDP - Japan is now the world’s third largest economy. Many analysts believed that Japan had begun to awaken from a decades-long economic malaise before the devastating earthquake earlier this year. That economic aftershocks of that quake are still being felt throughout the Japanese economy, and expectations for a surge in GDP related to reconstruction efforts have been pushed back to later in 2011.

Japanese Prime Minister Naoto Kan survived a no confidence motion on Thursday, but was forced to concede to opponents that he would step down once measures to address the reconstruction from the earthquake and the nuclear crisis were resolved. Japanese equities have trended lower in recent weeks on concerns of yet another leadership change (Japan has seen six prime ministers over the last five years) as well as anxiety about the struggles of the country’s automotive industry.

International Mid Cap ETFs

While there are dozens of ETFs offering exposure to mid-cap U.S. stocks, including value, growth and blend products, funds focusing on mid-cap stocks in international markets are relatively rare. Global X offers a Brazil Mid Cap ETF (NYSEARCA:BRAZ) that complements the large cap (NYSEARCA:EWZ) and small cap (NYSEARCA:EWZS) (NYSEARCA:BRF) options for accessing the Latin American economy. There are also a number of fund offering more broad-based international exposure to mid-cap stocks, focusing on developed markets outside the U.S.:

  • WisdomTree International MidCap Dividend ETF (NYSEARCA:DIM): This ETF focuses on European economies, and also maintains exposure to Japan and Australia. DIM charges an expense ratio of 0.58% and includes more than 350 stocks in the underlying portfolio.
  • PowerShares FTSE RAFI Developed Markets ex-U.S. Small-Mid Portfolio (NYSEARCA:PDN): This ETF is part of the growing suite of RAFI products from PowerShares, seeking to replicate a fundamentals-based index consisting of international stocks.
  • SPDR S&P International Mid Cap ETF (NYSEARCA:MDD): This ETF seeks to replicate an index consisting of international stocks with market capitalizations between $2 billion and $5 billion, including close to 500 stocks listed in more than a dozen different countries.

Disclosure: No positions at time of writing.

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