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ETF Specialist

New ETFs Look for Quality in Japan

These ETFs screen for companies with higher returns on equity and independent directors.

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Over the past three years, Japan’s stock market has responded very positively to the government’s efforts to kick-start its long moribund economy. Thanks to aggressive monetary easing, which started in 2013, the Japanese yen has fallen about 30% against the U.S. dollar. A weaker yen has been a boon for Japanese exporters, who have since been reporting stronger earnings growth. And as these export-oriented electronics and consumer firms continue to rally on improving earnings, financial firms have been able to reap higher profits from a stock market boom. Over the past three years, the Nikkei 225 benchmark has returned 120% (in yen), significantly outperforming the S&P 500’s 60% performance over the same time period.

Investors in Japanese equities have benefitted from these trends over the past few years, but a weakening currency is certainly not a sustainable solution for longer-term corporate earnings growth. Looking forward, the government is trying to address some long-standing issues that have weighed on the country’s growth potential--namely, corporate Japan’s indifference to returns and building shareholder value. Japan’s returns on equity have historically been about half that of the S&P 500 for a few key reasons. First, Japanese firms tend to hold an excess of rainy-day cash, an asset that generates almost no returns. Second, Japanese firms have a legacy of crossholdings, under which weak companies are kept afloat by their parent company. These practices are well entrenched in corporate Japan and are supported by an insular and staid corporate governance environment where directors have cozy relationships with their management teams and are loathe to push for change.

Patricia Oey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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