After a lackluster 2014, Japanese stocks have been on a tear this year buoyed by cheap massive money flows, rising corporate profits, corporate governance improvements and higher exports. Additionally, "Abenomics" has once again started to fuel growth in the Japanese economy.

Notably, the Nikkei 225 index rallied to the highest level in more than 18 years on Tuesday, returning nearly 20% in the year-to-date timeframe. It broke the 20,000 level for the first time in 15 years in late April. Though the index retreated from its peak in the past two trading sessions on the Greek impasse and profit booking activity, the bull run is likely to continue in the coming months given the recovering economic fundamentals (read:Nikkei Hits fresh 15-Year High: 3 Japan ETFs to Buy).

Bright Spots

The world's third-largest economy gained strong momentum in the first quarter with higher-than-expected growth. The economy grew 3.9% annually, up from preliminary reading of 2.4% thanks to the pickup in business investments, consumer spending and a higher inventory buildup.

At its latest monetary policy meeting, the Bank of Japan (BOJ) maintained its massive pace of asset purchase at 80 trillion yen per year to spur inflation and economic growth. However, lower oil prices are weighing on the country’s inflation, which has fallen to zero and is far from the BOJ target of 2%. Lower inflation could open up the doors for further policy easing later in the year that could drive up stocks.

Apart from these, Japan is primarily an export-oriented economy and a weaker currency makes its exports more competitive, prompting a rally in the stock market. But the most recent multi-year gains in the stocks came despite the fact that yen has shown some respite against the U.S. dollar in recent sessions after faltering to a twelve-and-half year low early this month, solidifying confidence in economic recovery.

Further, the Japanese stocks seem inexpensive at the current levels even after an astounding rally, as the stock market index is still well below the record high of 38,900 plus reached during the real estate bubble in 1989 (read: 4 Strong Reasons to Buy Japan ETFs Now).

Given that Japan is on the mend, investors seeking to participate in the recovery should definitely tap the currently beaten down stock price arising from the Greece uncertainty. For those, a focus on the top-ranked Japan ETFs could be a less risky way to tap the same broad trends.

How to Play?

While there are many ETFs that have top Zacks ETF Ranks of 1 (Strong Buy) or 2 (Buy) and are expected to outperform in the months to come, the funds that were promoted in the latest ranking upgrade could make for an ideal choice moving into the third quarter. This is because a number of factors such as the latest industry outlook, expert surveys, and ETF-specific factors helped in the spike seen by these ETFs (read: all the Top Ranked ETFs).

These funds have the potential to beat the market in the coming months, though they might not be so popular or leading the Japanese space so far this year. Further, these make for compelling cheap plays compared to many other top ranked funds in the space given the subsiding U.S. dollar strength on the prospect of the Fed’s slower-than-expected rate hike later this year.   

WisdomTree Japan SmallCap Dividend Fund ((DFJ - ETF report))

This fund targets the dividend paying small cap segment of the Japanese stock market by tracking the WisdomTree Japan SmallCap Dividend Index. Holding 617 securities in its basket, it has a spread out exposure to various components as each firm holds less than 0.9% of total assets. From a sector look, industrials and consumer discretionary take the top two spots at 25.2% and 23.4%, respectively, while materials, financials and information technology round off the next three with less than 13% allocation each.

The product has amassed $334 million in its asset base while trades in a lower volume of under 33,000 shares. It charges an annual fee of 58 bps and has gained about 18.1% in the year-to-date frame. The fund was upgraded to Zacks ETF Rank #2 from #3 (Hold).

iShares Japan Large-Cap ETF ((ITF - ETF report))

This fund is unpopular and illiquid, tracking the Japanese economy with AUM of $84.1 million and average daily volume of under 10,000 shares. It follows the S&P/TOPIX 150 Index and holds 150 stocks in its basket. Though it is slightly skewed toward the top firm – Toyota Motor – at 7.4%, other firms account for less than 4% of assets (see: all Developed Asia-Pacific ETFs here).

The product is widely spread out across sectors with consumer discretionary, industrials and financials occupying the top three positions at double-digit exposure each while others receive single-digit allocation. Expense ratio came in at 0.50%. The fund has added 16% so far this year and has seen upgradation by one notch to Zacks ETF Rank of #2.

SPDR MSCI Japan Quality Mix ETF ((QJPN - ETF report))

This fund has been on the market for a year and has attracted $13.4 million in its asset base. It charges 30 bps in fees per year from investors and trades is a paltry volume of around 3,000 shares. The product offers equal weight quality exposure combining three sets of factors – value, quality and low volatility. It tracks the MSCI Japan Quality Mix A-Series Index and holds 292 securities in its basket, with none holding more than 2.46% of assets (read: High Quality Stocks, ETFs to Beat the Market).

Here also, the ETF has well spread with exposure across various sectors with consumer discretionary, industrials, financials, information technology and consumer staples taking the top five spots. QJPN has returned 13.9% this year so far, much lower than many other funds in the space. However, it has seen its Rank surging by two notches to #1, suggesting that it could be an outperformer in the third quarter.