The Japanese economy is coping with a mountain of debt and some leftover Tsunami damage, and the varied implications of Japan's oil imports from Iran are a source of uncertainty. Nevertheless, I share the conviction of several astute investors that the worst is behind us, and that now is the time to buy into the Japanese stock market, focusing especially at the small-cap companies, in order to catch the coming rebound and to take advantage of their attractive valuation [price-to-book ratio of 0.66 compared with 2.25 in S&P 500 (SPY) index].
As I noted, some smart money is now flowing into the Japan. Charles de Vaulx, the French fund manager at International Value Advisers, has invested around 42% of IVA International A Fund (IVIOX) in the Japanese stock market.
Various ETFs deal with Japanese equities. The iShares MSCI Japan Index Fund (EWJ) is the most famous and popular Japanese equities ETF, with $5.61 billion in assets (February 21). However, EWJ's major investments are in the largest cap companies such as Canon (CAJ), Toyota (TM), Sony (SNE), Honda (HMC), Panasonic (PC) and Mitsubishi (MHVYF.PK) Some of these mega-companies can be more easily traded directly on the U.S. stock exchanges.
Investors who would like to get into the Japanese small-cap market and to invest in companies that cannot be traded directly on the American stock markets can look to the following three ETFs, which offer a good mix of small-cap companies with enough variation between them to allow for good diversification:
- WisdomTree Japan SmallCap Dividend Fund (DFJ)
- SPDR Russell/Nomura Small Cap Japan ETF (JSC)
- iShares MSCI Japan Small Cap Index Fund (SCJ).
Both the net assets and the trading volumes of these three ETF are quite small. DFJ is the most liquid with $192.4 million in assets and with average trading volume of 30,351; JSC $90.4 million with 8,000 stocks; and SCJ $54.4 million and 7,850.
I believe that in the not-so-distant future both assets and volume of these ETF will increase substantially.
DFJ, JSC and SCJ are running diversified holding of between 300-550 holdings. SCJ's focus is mainly the financial sector, while DFJ and JSC focus on materials. DFJ also seeks to follow small-cap dividend-paying equities.
As for the 3-year average return:
DFJ registered 10.02%,
CSJ registered 3.82%,
SCJ registered 10.41%.
All three ETFs registered healthy returns YTD of around 6%.
Bottom line: I believe Japan small-cap equities should be part of your portfolio, and the three ETFs mentioned here offer good exposure. DFJ's advantage is its better liquidity. JSC's uniqueness is its investment in the smallest Japanese companies, and SCJ's specialty is in investing mainly into Japan's financial sector.