Japan may finally be about to break the spell of low inflation and low growth that has plagued Japanese equities since the 90s.
With the implementation of reforms to make the Japanese stock market more efficient and Warren Buffett recently giving his seal of approval to Japanese equities, now may be a good time to be bullish on Japan.
This has led some wealth managers to increase the allocation to Japan in their clients’ portfolios.
While wealth managers tend to prefer the active way in Japan due to structural issues in the local stock market, a passive fund remains a cheaper option.
But a peculiarity of Japanese trackers is that there is less uniformity in the index they track.
While US passive funds would typically track the S&P 500 and UK blue-chips trackers the FTSE 100, their Japan peers tend to benchmark themselves against several different indices.
MSCI Japan has been the best performing Japanese index over five years, as it would have turned £1,000 into £1,172.87.
Returns of funds over five years for £1,000 invested
Source: FE Analytics
Yet, the Japan passive fund that would have delivered the best return in that period is iShares Nikkei 225 UCITS ETF, which tracks the Nikkei 225.
While £1,000 in the Nikkei 225 would have returned £1,161.5 five years later, iShares Nikkei 225 UCITS ETF would have turned those £1,000 into £1,237.94, a 7.6% difference.
Rob Perrone, investment counsellor at Orbis Investments, said: “The absolutely key thing to understand about the Nikkei 225 is that it weights companies by price, not by market capitalisation. Most headline indices, especially those used for tracker funds, are weighted by market capitalisation.
“With price weighting, a ¥500bn company with a share price of ¥1,000 could have a lower weight than a ¥100bn company with a share price of ¥5,000.”
For instance, the top stock in the Nikkei 225 is Uniqlo, which has a market value of about £60bn, but its weight in the index is ten times that of Toyota Motor, despite a market value of over £159bn.
Perrone added: “This makes no sense for an index tracker and the Nikkei 225 ought to be a historical relic. The closest comparison to the Nikkei is the Dow Jones Industrial Average in the US, which is also price weighted.
“Unlike the Dow, which is typically ignored by professionals and rarely used in futures contracts or index trackers, the Nikkei remains widely used in futures and ETFs.”
Fidelity Index Japan would have delivered the second best performance for investors. It returned £1,181.86 after five years, or £8.99 more than its MSCI Japan benchmark.
MSCI Japan tracks the returns of large- and mid-cap stocks, weighted by market capitalization and has under 250 constituents.
Perrone said: “MSCI Japan would be comparable to the S&P 500 or Russell 1000 in the US. In the UK, the closest comparison to MSCI Japan would be the FTSE 350.”
HSBC Japan Index is the third best performing and benchmarks itself against the FTSE Japan index.
FTSE Japan is a market capitalisation weighted index of 514 constituents, representing the performance of Japanese large- and mid-cap stocks.
Performance of indices over 5yrs
Source: FE Analytics
Lyxor Japan (TOPIX) (DR) UCITS ETF is the tracker in the list that would have delivered the least for investors, turning £1,000 into £1,102.74. That is 2.6% less than its Topix benchmark.
Perrone said: “The Topix tracks the returns of all shares listed on the ‘big board’ of the Tokyo Stock Exchange, weighted by market capitalization. Tokyo is one of the world’s broadest and deepest stock exchanges, so the Topix captures a huge number of very small companies.
“The Topix has over 2,000 constituents, but over 90% of its weight is in the largest 500 companies. In the US, the Topix would be comparable to the NYSE Composite Index. The closest UK comparison to the Topix would be the FTSE All-Share Index.”