Japan Macro and Flows Trade Back On by Jeremy Schwartz, Director of Research, The WisdomTree Blog
For much of 2014, Japan disappointed investors who were expecting greater stimulus from the Bank of Japan (BOJ). Prior to its most recent action on October 31, the majority of economists expected no additional action from the BOJ1. The surprise easing announcement—which consisted mostly of tripling its purchases of exchange-traded funds (ETFs) and real estate investment trusts (REITs)2 —sent the yen down and stocks up. The timing of these additional measures followed less monetary easing by the U.S. central bank3 as well as a transition from the Japanese Government Pension Investment Fund (GPIF)4. Talk about a powerful one-two punch—in one move, the BOJ offset worries about declining global liquidity out of the U.S. central bank and provided support to the GPIF (as it sells Japanese government bonds) while helping to boost equity purchases.
This puts the focus back on the macro trades that worked well in 2013: a weak yen championed by BOJ stimulus, supported by inflows of more than $150 billion of foreign money into Japan’s equity markets that sent Japan’s markets soaring.5
So where should macro trades be focused?
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To start, we believe currency-hedged strategies are a great way to focus on the pure equity opportunity represented by Japan. As a reminder, traditional international exposures typically involve two sources of risk: equity risk and currency risk. Further, in the case of Japan, there is an inverse correlation between the yen and the equity markets—i.e., when the yen is on the decline (as it currently is), equities tend to rise.
WisdomTree launched currency-hedged ETFs to help neutralize the foreign exchange rate risk from impacting returns to U.S. investors. Now let’s review the performance of different parts of the Japanese market, all on a currency-hedged basis.
Figure 1: Average Annual Returns of WisdomTree Japan Hedged Indexes (as of 9/30/14)
Figure 2: WisdomTree’s Japan Hedged Indexes Respond to the Bank of Japan’s 10/31/14 Announcements
For definitions of Indexes in the chart, please visit our glossary.
We see three main categories of interest for macro investors:
1) Exporters: that benefit from a weak yen. Japanese companies are expected to increase their focus on profitability metrics like return on equity (ROE), and more dividends and buybacks are expected as companies better manage the cash on their balance sheets to be more globally competitive. The WisdomTree Japan Hedged Equity Fund (DXJ), the ETF built to track the performance of the WisdomTree Japan Hedged Equity Index, is symbolic of this current market theme and offers investors access to its multinational exporters.
2) Small caps: are a more local Japanese economy play, and if Shinzo Abe, the prime minister of Japan, is successful at generating wage growth, these stocks could have some longer-term suport despite unfavorable demographic trends. And despite fears of a consumption tax hike, small caps were outperforming their large-cap global peers prior to the stimulus provided by the BOJ.6
The WisdomTree Japan Hedged SmallCap Equity Fund (DXJS), the ETF designed track the WisdomTree Japan Hedged SmallCap Equity Index, provides investors with access to this important segment. Further, the total price-to-book-ratio of this Fund is just 0.91—which means in aggregate terms the companies within the Index are selling at a price below liquidation value, or net assets7. Two hundred eighty-five of the 599 companies and more than 45% of the weight of the Fund have a price-to-book ratio less than 1.0.8
3) Financials and Real Estate: Some of the most direct beneficiaries of the BOJ stimulus were financial and real estate companies, which were up more than 6% on the day of the announcement (see Figure 2). Real estate companies received direct support, as the BOJ was directly buying REITs. Real estate9 was the second worst performing sector prior to the BOJ announcement10, so it is not a surprise that it popped on the news. Financials11 were the worst performer, down more than 10%12, and that sector too popped more than 6% on the news. If the macro trades are back on, these two sectors may continue to be beneficiaries.
The WisdomTree Japan Hedged Financials Fund (DXJF), the ETF designed to capture currency-hedged Japanese financials by tracking the performance of the WisdomTree Japan Hedged Financials Index, and the WisdomTree Japan Hedged Real Estate Fund (DXJR), the ETF designed to capture currency-hedged Japanese real estate by tracking the performance of the WisdomTree Japan Hedged Real Estate Index, provide investors with access to these opportunities.
For more information on the rest of the Japanese sector offering, click here.
1Source: Andrea Wong, “Yen Declines to 7-Year Low on BOJ Monetary Easing,” Bloomberg, 10/31/14.
2Source: “Expansion of the Quantitative and Qualitative Monetary Easing,” Bank of Japan, 10/31/14.
3Source: Chris Matthews, “Are we Really Saying Goodbye to QE Forever?” Fortune, 10/29/14.
4Source: Adam Haigh, Yoshiaki Nohara and Shigeki Nozawa, “Japan Pension Fund Said to Unveil Asset Allocations Today,” Bloomberg, 10/31/14.
5Source: Bloomberg, for period 12/31/12–12/31/13.
6Sources: WisdomTree, Bloomberg, 12/31/13–10/30/14.
7Sources: WisdomTree, Standard & Poor’s, with data as of 10/31/14.
8Sources: Bloomberg, Standard & Poor’s, with data as of 10/31/14.
9Refers to the WisdomTree Japan Hedged Real Estate Index.
10Measured against the other WisdomTree Japan Hedged Indexes for the period 12/31/13–10/30/14.
11Refers to the WisdomTree Japan Hedged Financials Index.
12Measured against the other WisdomTree Japan Hedged Indexes for the period 12/31/13–10/30/14.
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Funds focusing their investments on certain sectors increase their vulnerability to any single economic or regulatory development. This may result in greater share price volatility. The Funds focus their investments in Japan, thereby increasing the impact of events and developments in Japan that can adversely affect performance.
Investments in currency involve additional special risks, such as credit risk, interest rate fluctuations, derivative investment risk and the effect of varied economic conditions. Derivative investments can be volatile, and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions.
As these Funds can have a high concentration in some issuers, the Funds can be adversely impacted by changes affecting those issuers. Due to the investment strategy of these Funds, they may make higher capital gain distributions than other ETFs. Please read the Funds’ prospectuses for specific details regarding the Funds’ risk profile.
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There are risks involved with investing, including possible loss of principal. Foreign investing involves currency, political and economic risk. Funds focusing on a single country, sector and/or funds that emphasize investments in smaller companies may experience greater price volatility. Investments in emerging markets, currency, fixed income and alternative investments include additional risks. Please see prospectus for discussion of risks.
Past performance is not indicative of future results. This material contains the opinions of the author, which are subject to change, and should not to be considered or interpreted as a recommendation to participate in any particular trading strategy, or deemed to be an offer or sale of any investment product and it should not be relied on as such. There is no guarantee that any strategies discussed will work under all market conditions. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This material should not be relied upon as research or investment advice regarding any security in particular. The user of this information assumes the entire risk of any use made of the information provided herein. Neither WisdomTree nor its affiliates, nor ALPS Distributors, Inc., or its affiliates provide tax or legal advice. Investors seeking tax or legal advice should consult their tax or legal advisor. Unless expressly stated otherwise the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.
Jonathan Steinberg, Jeremy J. Siegel, Luciano Siracusano III, Jeremy Schwartz, David Abner, Rick Harper, Sean Kelly, Christopher Gannatti, Bradley Krom, Tripp Zimmerman, Eswarie Subrahmanyam S. Balan, Zachary Hascoe, and Anita Rausch are registered representatives of ALPS Distributors, Inc.
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