Abenomics Boosting Japan Small-Cap ETFs

If ETFs could participate in karaoke night, those funds tracking Japanese small-caps might be apt to select the 1980s classic "Don't You Forget About Me." The Simple Minds hit is an appropriate one for Japanese small-cap ETFs because as the yen has plunged and the Nikkei has soared in recent months, the WisdomTree Japan Hedged Equity Fund (NYSE:DXJ) and the iShares MSCI Japan Index Fund (NYSE:EWJ) have dominated the Japan ETF conversation.

Investors are not likely to complain about the performances of either DXJ or EWJ. The rapidly growing DXJ is has surged almost 18 percent year-to-date while EWJ, still the largest Japan ETF by assets, is up 9.1 percent.

Clearly, Abenomics, the term coined for Prime Minister Shinzo Abe's efforts to devalue the yen while boosting Japan's rate of inflation, has been kind to DXJ and EWJ. ETFs tracking Japanese small-caps are getting in on the act, too, though these funds remain overshadowed by DXJ and EWJ.

Overshadowed or not, there is no denying that ETFs such as the WisdomTree Japan SmallCap Dividend Fund (NYSE:DFJ) have started to perform quite nicely in the past month. Put DXJ, EWJ, DFJ and DFJ's two nearest rivals side-by-side over the past month and the result may come as a surprise to some investors. In that group of five ETFs, DXJ and EWJ, place fourth and fifth, respectively.

Over the past month, the gold medal for Japan ETF performance goes to a fund ETF critics would love to hate: The SPDR Russell/Nomura Small Cap Japan ETF (NYSE:JSC). As of March 14, JSC had just $66.3 million in assets and average daily volume of about 8,000 shares per day.

Notable is the fact that on volume that was more than 25 percent above the daily average, JSC rose to its highest levels since late 2007 on Friday. Factor in Friday's almost 0.9 percent gain, and JSC is up nearly 10.7 percent in the past month.

Interestingly, JSC is not as volatile as some investors might think it is. This is a small-cap ETF with annualized volatility of 12.78 percent and a beta of 0.41 against the S&P 500, according to State Street data. By comparison, EWJ has a beta of 1.13 against the S&P 500.

The aforementioned WisdomTree Japan SmallCap Dividend Fund and the iShares MSCI Japan Small Cap Index Fund (NYSE:SCJ) essentially tie for second place among Japan ETFs over the past month with each sporting gains of about 9.8 percent.

The WisdomTree Japan SmallCap Dividend Fund is the largest of the Japan small-cap ETF trio with $171.6 million in assets. Although DFJ does not feature the USD/JPY hedge that has made DXJ so popular with investors, the small-cap offering is intimately levered to the weak-yen-helps-Japanese-exporters story. DFJ devotes 45.7 percent of its combined weight to industrial and consumer discretionary firms, which gives the ETF some positive exposure to a weakening yen as those export-intensive industries in Japan.

DFJ's underlying index compares favorably with the MSCI Japan Small Cap Index, the index tracked by SCJ. Since inception in June 2006, DFJ's index has outpaced SCJ's index while being less volatile, according to WisdomTree data.

That does not mean SCJ is not worth a look. The $57.6 million ETF has an expense ratio of 0.51 percent, making it slightly cheaper than both DFJ (0.58 percent) and JSC (0.55 percent). SCJ is also the largest of the Japan small-cap ETF trio with 724 holdings compared to almost 430 for DFJ and 388 for JSC.

Additionally, the iShares offering makes for a credible weak yen play with a 22 percent allocation to the industrial sector and an almost 20 percent weight to consumer discretionary stocks.

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