The MSCI Japan Index is designed to measure the performance of the large- and mid-cap segments of the Japanese equity market. With 300-325 constituents, the index covers approximately 85% of the free-float adjusted market cap in Japan.
Components must meet minimum criteria for liquidity, foreign ownership restrictions, and a waiting period for newly listed stocks. The free-float adjustment serves to ensure higher underlying liquidity relative to a pure market-cap weighting. The index is well diversified across industries.
At the time of writing, the biggest exposures were industrials (20%), consumer cyclicals (18%), and financials (11%). On a company level, Toyota was at the top with a weighting of 4%, followed by Softbank Group (2%). All remaining constituents were below 2%.
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The fund has an ongoing charge of 0.35%, a figure that approximates the median value for MSCI Japan trackers but much cheaper options exist. The fund maintains a considerable cost advantage when compared with active peers.
The annual tracking difference (fund return less index return) for the fund over the trailing three-year period has hovered around its ongoing charge.
Other potential costs for the investor include bid-ask spreads and brokerage fees when buy and sell orders are placed for the ETF.
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The fund uses full physical replication of the MSCI Japan Net Total Return Index. This means that the fund holds all the index securities in the same weightings stipulated by the index. The fund uses futures for cash management purposes. This is standard practice and helps limit tracking error.
UBS engages in securities lending and may lend up to 50% of its assets to generate revenues and thus help improve the fund's tracking performance.
The fund lent out 20% of fund holdings on average over the 12 months to the beginning of March 2019 and received net lending returns of 0.05%. The maximum the fund lent out at any given time over the past year was 42%. The gross lending revenue generated can
partially offset the total expense ratio, and is split 60/40 between the ETF and State Street Bank GmbH, which acts as lending agent.
This practice introduces counterparty risk, as the party to whom the securities are lent may default, and it is left to investors to decide whether or not the additional income generated through securities lending is an adequate compensation for the risk level entailed.
To minimise counterparty risk, UBS restricts securities lending to predefined counterparties, holds collateral in a ring-fenced third party with State Street Bank and marks the collateral's value to market daily. UBS and third-party agents, such as Clearstream
Banking and Euroclear, manage the securities-lending process, including monitoring collateral values.
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UBS-ETF MSCI Japan represents a solid option for investors looking to access the Japanese large-cap equity market, but we withhold our highest levels of conviction for low-cost peers that track broader and more representative indexes such as the MSCI Japan Investable Market Index and Tokyo Stock Price Index.
The market-cap-weighted MSCI Japan Index tracks the performance of around 320 large- and mid-cap Japanese companies, which represent around 85% of the total market value. With an ongoing charge of 0.35%, this fund maintains a considerable cost advantage when compared with active peers. However, there are significantly cheaper funds tracking the same index; for example, Fidelity Index Japan has an ongoing charge of just 0.10%.
Performance has been solid, the fund has edged-out surviving peers on risk-adjusted basis over, three, five, and 10 years.
The annual tracking difference (fund return less index return) has hovered around the ongoing charge over the last three years. This suggests that the fund has tracked its benchmark tightly (gross of fees). Net of fees, the fund has been one of the better-performing MSCI Japan exchange-traded funds.
Investors in all foreign markets should be aware of the potential impact that currency movements can have on returns. For example, a UK investor in the Japanese equity markets is exposed to both the returns on the underlying market and the fluctuations in the pound/yen exchange rate. Over long periods, the impact of exchange-rate fluctuations is likely to be a wash, consistent with the historical pattern.
While we remain confident that this fund will outperform its category peers on a risk-adjusted basis over the full market cycle, we reserve our highest levels of conviction for broader and cheaper passive options.
For this reason, we have awarded this fund a Morningstar Analyst Rating of Bronze.
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Passive investors in broad Japanese equities have an eclectic box of indexes from which to select their preferred tool. Even among cap-weighted funds, there is a range of different-sized options to consider.
Of these, the most tracked index by ETFs in Europe is the MSCI Japan. With around 320 constituents, this index captures approximately 85% of the free-float-adjusted market capitalisation and is designed to measure the performance of the large- and mid-cap segments of the Japanese equity market.
Broader in terms of size, with almost 500 constituents, is the cap-weighted FTSE Japan Index, which also attempts to capture the performance of large- and mid-caps. The MSCI Japan IMI expands coverage to include small caps with around 1,300 holdings, which represent 99% of the free-float-adjusted market cap in Japan.
Rounding out the cap-weighted options is the sprawling TOPIX, which approximates total market coverage with close to 2,100 constituents. Elsewhere, the JPX Nikkei 225 Index weights constituents by stock price rather than by market cap. This approach to indexing has largely fallen out of favour, partly because firms find themselves directly in control of their own weighting in the index. Also, being one of the narrowest major Japanese equity indexes available, the Nikkei 225 is also the most concentrated.
Not to be confused with its cousin the Nikkei 225, the JPX Nikkei 400 is a different investment proposition altogether. It was launched in early 2014 as part of a government initiative to give incentive to better corporate governance. It screens its 400 constituents by several factors, including return on equity, operating profit, and corporate governance credentials. The selected stocks are then weighted by their market capitalisation, with a 1.5% cap applied on individual names. The result largely resembles an unscreened cap-weighted index.
Over the trailing 15-year period (to March 2019), index Sharpe ratios have fallen in line with theoretical predictions. The TOPIX has been the top performer over the period. It is followed by the MSCI Japan IMI, FTSE Japan and MSCI Japan, each of which have progressively lower risk-adjusted returns than the last over the same periods.
However, over shorter periods of time, differences in risk and return profiles may emerge. Investors seeking exposure to domestically focused Japan exposure and smaller companies should favour MSCI Japan IMI or TOPIX over the other indexes.
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There are many options to gain exposure to the Japanese equity market. The range of available funds enables investors to invest via a variety of standard market-cap as well as strategic-beta indexes.
Currently, of all the ETFs tracking the MSCI Japan Index, HSBC MSCI Japan ETF has the lowest ongoing charge at 0.19%.
IShares Core MSCI Japan IMI ETF and Vanguard FTSE Japan ETF each offer broader (1,300 and 500 constituents, respectively) exposure than iShares MSCI Japan ETF for a low fee (ongoing charges of 0.20% and 0.19%, respectively).
Another popular alternative to access the Japanese equity market is the Nikkei 400 Index. It uses qualitative and quantitative scoring to select 400 companies that meet specific quality requirements and have an investor-focused management approach. Currently, Amundi (0.18% ongoing charge) and Invesco (0.20%) offer the cheapest Nikkei 400 products.
Finally, the broadest market exposure to Japanese equity is provided by funds tracking the TOPIX, which is made up of around 2,100 constituents. Amundi Japan Topix ETF currently has the lowest ongoing charge of 0.20%.
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