Japan ETF Definition

What Is a Japan ETF?

A Japan ETF is an exchange-traded fund (ETF) that invests the majority of its assets in Japanese assets that trade on local stock exchanges. These ETFs are diversified investments that have a low initial investment requirement and management costs.

Just like company stock, Japan ETFs trade on stock exchanges. They provide investors access to the Japanese economy through currency, equity, and fixed-income markets. Investors can choose from more than a dozen options that trade on U.S. stock exchanges.

How Japan ETFs Work

Investing in foreign stock markets was something only sophisticated traders could ever hope to achieve in the past. But average investors have been able to get into the market, giving them the chance to profit from the global shifts in capital. This movement of money has a lot to do with the advance of exchange-traded funds.

ETFs pool assets from investors who have similar goals. They are listed on exchanges and trade throughout the day just like ordinary stocks. They strive to replicate the performance of a broad equity market, specific sector, or trend by mirroring the holdings of a designated index. This is a hypothetical portfolio of securities representing a particular market or a segment of it.

Japan ETFs provide international investors with an easy way to gain exposure to the country without buying individual stocks and placing all their eggs in one basket. These vehicles are managed passively around a broad underlying index, such as the MSCI Japan Index, whose constituents cover approximately 85% of the free float-adjusted market capitalization in the country.

Investors can choose from 20 Japan ETFs that trade on U.S. stock exchanges as of Jnuary 2024. Together, they hold combined assets of about $31 billion. These ETFs track eight major indices on Japan's stock market. This is in addition to those that track small- and mid-cap investment strategies and currencies.

Special Considerations

Japan is an advanced economy with a large equity market. That means there are plenty of ETFs to choose from, including more exotic ones that focus exclusively on the country’s smaller, up-and-coming companies, dividends, or value stocks. As with several of the larger, more liquid ETFs, some Japan ETFs can be sold short and are even accessible through listed options.

Having said that, many investors underestimate the effects that currency fluctuations can have on total returns. If the U.S. dollar rises in value against the Japanese yen (JPY), then an unhedged ETF will suffer currency losses that can offset any gains in the underlying Japanese stock market.

During periods of dollar strength, many investors found currency risk undesirable, paving the way for a rise in a category of ETFs that hedge out currency risk. Their goal is to give investors a return closer to the local currency returns of a country’s major stock market indexes.

Advantages and Disadvantages of Japan ETFs

There's no doubt that investing in Japan ETFs allows investors to diversify their holdings and get into a new market. But there are other benefits to trading shares in these investments. Similarly, there are downsides to adding these vehicles to an investment portfolio. We've listed some of the key pros and cons associated with Japan ETFs below.

Advantages

Japan has the third-largest economy in the world by nominal GDP, and is the home to many world-leading industrial and tech giants. The country's leading position in the world economy makes it a desirable destination for retail investors worldwide.

The Japan Exchange Group, which owns the Tokyo Stock Exchange (TSE), is a large and progressive stock exchange in the Asia Pacific. This makes the country a frequent source of investor focus and attention. Japan ETFs allow for a single diversified investment in the country, while also making a bet on the strength of the yen versus the dollar.

Disadvantages

Japan has a fair number of economic issues, including decades of deflation, an aging population, and high levels of debt.

Japan's market is also more limited than others—notably, the U.S. ETF market—both in size and variety. This difference could be attributable to the fee structure for the Asian market in general. In the U.S., the trend has been toward a fee-only fiduciary model for many investments. In Asia, on the other hand, many investment products continue to be sold by agents on commission.

Example of a Japan ETF

The iShares MSCI Japan ETF (EWJ) is perhaps the best-known ETF in this category. The fund aims to produce investment results that correspond to the MSCI Japan Index using a market capitalization-weighted method. In other words, a company’s representation is based on its size.

iShares’ Japan ETF and the MSCI Japan Index are very similar, ensuring little tracking error. Both are led by Toyota (TM), which accounts for over 5% of total assets as of January 2024, consisting mainly of industrials, consumer discretionary, financials, and technology stocks.

The Bottom Line

A Japan ETF invests in a basket of Japanese equities, allowing international investors to gain exposure to one of the world's largest manufacturing economies. Like other ETFs, Japan ETFs provide diversified exposure to a broad cross-section of the country's economy without relying on the success of any one company. However, international ETFs also come with some extra risks.