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Weak Yen Weighs on Japan ETF Performance

tlydon@globaltrend.com (Tom Lydon)

Exchange traded funds that invest in Japan are in the green for 2012, despite sliding lower in April. However, a weak yen is hurting the performance of Japanese ETFs that don’t hedge their foreign currency exposure.

The Bank of Japan has targeted expanding the monetary base in the country ever since the earthquake and tsunami struck. As the yen now faces a weakening trend against the U.S. dollar, can ETF investors make gains in Japanese equities?

“Relative to other developed markets, Japanese equities (U.S. dollar returns) have had a low correlation to U.S. equities and more recently have exhibited less volatility. However, lower correlations were caused by the fact that Japanese equities have been weak performers because of a sluggish domestic economy and a rising yen, which hurt Japan’s exporters,” Patricia Oey wrote in a Morningstar fund analysis. [Why Japanese Yen ETFs Are Getting Crushed]

After falling off in 2011, Japanese equities have been rebounding in 2012. The Bank of Japan’s monetary expansion to $1.37 trillion has helped to stabilize the economy and has now put pressure on the yen, reports Alec Young, S&P Equity Analyst on MarketScope. [Why Japanese Yen ETFs are in Free Fall]

Profit taking has since occurred among currency traders, and as a result, safe haven investments such as the Japanese yen have fallen out of favor. The stability that the U.S. economy has conveyed and the default aversion in the Eurozone have given investors enough reason to take on more risk. [Currency ETF Chart of the Day: Japanese Yen]

U.S. investors that own foreign stocks may have suffered as the Japanese yen has lost strength to the U.S. dollar. The greenback has gained 6.7% in 2012 against the yen, impacting U.S. investors dollar denominated Japanese equity gains. For example, the MSCI Japan Index is up 17.6% in local terms, but only 10% when measured in U.S. dollars. The S&P 500 has gained 12.4% in comparison.

The result is that it is difficult for Japan  to consistently outperform international equity benchmarks in U.S. dollar denominations. The iShares MSCI Kokusai Index Fund (NYSEArca: TOK) tracks an index that is unique in that it offers exposure to developed international markets, ex-Japan. [Diversify By Investing with Non-Correlating ETFs]

An ETF that focuses in on Japan’s stock market and hedges foreign currency exposure is the WisdomTree Japan Hedged Equity (NYSEArca: DXJ).

The db-X MSCI Japan Currency-Hedged Equity Fund (NYSEArca: DBJP) also mitigates exposure to fluctuations between the value of the U.S. dollar and Japanese yen.

Tisha Guerrero contributed to this article.