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What is a 'Japan ETF'

A Japan ETF is a type of exchange-traded fund that invests the majority of its assets in Japanese equities that trade on local stock exchanges. In the Japanese stock market, ETFs track seven indices. Three alternative indices that focus on small- and mid-cap or equity strategies are available as well. The performance of Japan ETFs does not correlate to the performance of the underlying index when measured in U.S. dollars because the change in the exchange rate between the yen and the dollar must be taken into consideration. 


Japan ETFs are managed passively around a broad underlying index, such as the MSCI Japan Index, which represents more than 75 percent of the total market capitalization of all listed Japanese equities. 

The Tokyo Stock Exchange is one of the largest and most progressive markets in Asia, making 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.

Because of the depth of Japan's equity markets, ETFs that focus on large- or small-cap stocks are available. As with several of the larger, more liquid ETFs, some Japan ETFs can be sold short and are even accessible through listed options. The iShares MSCI Japan ETF is a straightforward way to gain exposure to Japan’s stock market. Industrials and consumer discretionary stocks figure prominently in the portfolio, along with financials and technology stocks. 

Overall, though, Japan’s ETF market is more limited than 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. However, in Asia many investment products continue to be sold by agents on commission.

Japan ETFs and Currency Hedges

Many investors underestimate the effects that currency fluctuations can have on total returns. However, currency-hedged ETFs can help mitigate currency risk in their investments. 

If the U.S. dollar rises in value against the Japanese yen, 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, which gave rise to a category of ETFs that hedge out currency risk. The goal is to give investors a return closer to the local-currency returns of a country’s major stock-market indexes.

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