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Japanese stocks have been on the hottest ride over the past several months, with the Nikkei 225 Index now breaching the 40,000 milestone for the first time. The surge was driven by a wave of positive factors, including hopes for U.S. interest rate cuts, cooling inflation signs, and a burgeoning interest in artificial intelligence (AI) within the technology sector.

This landmark achievement underscores a significant rally fueled by foreign investments, buoyed by a cheap yen and corporate governance reforms that have boosted shareholder returns. Investors seeking to tap the robust rally should definitely invest in Japan ETFs.

While most of Japan's ETFs have been on the surge this year, currency-hedged funds are leading the space. These include WisdomTree Japan Hedged Equity Fund (DXJ - Free Report), Xtrackers MSCI Japan Hedged Equity ETF (DBJP - Free Report), iShares Currency Hedged MSCI Japan ETF (HEWJ - Free Report), Franklin FTSE Japan Hedged ETF (FLJH - Free Report) and WisdomTree Japan Hedged SmallCap Equity Fund (DXJS - Free Report). These ETFs have a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.

Currency-hedged ETFs are outperforming their unhedged peers as the surging U.S. dollar is knocking down the returns of international investments. This is because a strong greenback eats away foreign investment gains when repatriated in U.S. dollar terms, pushing them into the red even when international stocks are performing well. As such, the strength in the greenback has compelled investors to flock to currency-hedged ETFs.

The resurgence in Japan’s market is attributed to several key factors:
 

Increased Foreign Flows

Foreign investors poured huge amounts of money into Japanese stocks in order to take advantage of the depreciated yen and enhance corporate governance. The surge in inflows is also attributable to the capital moving out from China amidst its economic and property market challenges, thereby increasing liquidity in Japan's markets and the rally in the stocks.

In particular, billionaire investor Warren Buffett's Berkshire Hathaway sparked interest in Japanese stocks by boosting his holdings in Japan's top five trading firms - Mitsubishi, Itochu, Mitsui & Co., Sumitomo, and Marubeni - to around 9%, according to the latest Buffett's annual letter to shareholders. This underscores the bullish call on Japan stocks.
 

Weak Yen and Economic Policies

The Japanese yen's weakening against the dollar, influenced by Bank of Japan (“BoJ”) governor Kazuo Ueda's remarks on not yet achieving the central bank's 2% inflation target sustainably and stably, has benefited exporters. This currency dynamic enhances the competitiveness of Japanese products overseas, boosting the earnings of export-oriented companies.

Meanwhile, BoJ’s monetary policy, particularly its stance on maintaining a negative interest rate policy, underscores a cautious approach to achieving inflation targets. This policy has implications for liquidity and investment in Japan’s market, sustaining interest among investors.
 

Solid Earnings and Wage Rise

A significant boost came on the back of solid corporate earnings, with the last quarter of 2023 witnessing a 45% year-on-year increase, as reported by Goldman Sachs analysts. The outlook for earnings has improved, given the recovery in global manufacturing activity, as global demand for goods revives.

Additionally, wage hikes in response to a tighter labor market by major companies like Toyota, Nintendo, and Fast Retailing have further strengthened economic optimism.
 

ETFs in Focus

WisdomTree Japan Hedged Equity Fund (DXJ - Free Report) – Up 17.4%

With an AUM of $4.4 billion, WisdomTree Japan Hedged Equity Fund seeks to provide exposure to the Japanese equity market while hedging exposure to fluctuations between the U.S. dollar and the yen. It targets the Japanese equity stock market without the currency risk by tracking the WisdomTree Japan Hedged Equity Index.

WisdomTree Japan Hedged Equity Fund trades in a good average daily volume of 939,000 shares and charges 48 bps in annual fees.

Xtrackers MSCI Japan Hedged Equity ETF (DBJP - Free Report) – Up 15.2%

Xtrackers MSCI Japan Hedged Equity ETF tracks the MSCI Japan U.S. Dollar Hedged Index, which is designed to provide exposure to Japanese equity markets while at the same time mitigating exposure to fluctuations between the value of the U.S. dollar and Japanese yen.

With an AUM of $354 million, Xtrackers MSCI Japan Hedged Equity ETF trades in an average daily volume of 24,000 shares and charges 47 bps in fees per year.

iShares Currency Hedged MSCI Japan ETF (HEWJ - Free Report) – Up 15.1%

This is a hedged version of the popular fund iShares MSCI Japan ETF (EWJ). It offers broad exposure to a wide range of Japanese companies that may potentially benefit from the country’s stimulus policies while mitigating exposure to fluctuations between the value of the Japanese yen and the U.S. dollar.

iShares Currency Hedged MSCI Japan ETF has amassed nearly $302.7 million in its asset base and sees a volume of about 140,000 shares a day. It charges 50 bps in fees per year from investors.

Franklin FTSE Japan Hedged ETF (FLJH - Free Report) – Up 14.6%

Franklin FTSE Japan Hedged ETF provides access to the Japanese stock market and seeks to reduce the impact of the yen relative to the U.S. dollar. It follows the FTSE Japan Capped Hedged Index and comes at a low cost with an expense ratio of 0.09%.

Franklin FTSE Japan Hedged ETF has accumulated $39 million in its asset base while trading in an average daily volume of 26,000 shares.

WisdomTree Japan Hedged SmallCap Equity Fund (DXJS - Free Report) – Up 8.9%

With an AUM of $58.3 million, WisdomTree Japan Hedged SmallCap Equity Fund offers exposure to the small-cap segment of Japan’s equity market while hedging exposure to fluctuations between the U.S. dollar and the yen. It follows the WisdomTree Japan Hedged SmallCap Equity Index.

WisdomTree Japan Hedged SmallCap Equity Fund trades in a solid volume of 22,000 shares per day and charges 58 bps in annual fees.

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