Actively managed Japanese stock ETFs outperform in resilient market By Reuters

By Suzanne McGee and Tom Westbrook

(Reuters) – Less than a month after an interest rate hike by the Bank of Japan triggered the biggest sell-off since 1987, major market benchmarks have rebounded from lows, although they have yet to return to levels recorded at the end of July.

That may be good news for some actively managed exchange-traded funds (ETFs), market analysts said.

Index-based products continue to dominate the Japan-focused ETF universe, both in terms of numbers and assets under management. But issuers of newer and still small actively managed ETFs say they have used the selloff to do what index funds can’t: pick for their discounted portfolios companies they believe will outperform over the long term.

“We think taking an active approach to investing in Japan works best,” said Shuntaro Takeuchi, manager of the Matthews Japan Active ETF. “You can take advantage of the opportunities that exist when certain stocks vary dramatically from their intrinsic value,” as happened during the selloff, he said.

The one-year-old fund with just $3.8 million in assets is the smallest Japan-focused ETF listed in the U.S. but has returned 21.7 percent so far this year, according to LSEG. That compares with a year-to-date gain of 11.3% for its largest partner, the $15.9 billion index-based iShares MSCI Japan ETF, and a 14.6% return for Nikkei 225.

Japan is fertile ground for active stock picking because the largest Japanese stocks do not dominate the major indexes the way the “Magnificent Seven” tech stocks do in the index, Takeuchi told Reuters on the latest episode of Inside ETFs.

“That leaves room for stock picking,” Takeuchi said, including in areas such as factory automation, construction, technology, conglomerates and retail companies.

In April, when Rayliant Global Advisors launched its new Japan ETF, the Rayliant SMDAM Japan Equity ETF in partnership with Sumitomo-Mitsui DS Asset Management, it also opted for an actively managed strategy. In the four months since launch, the fund has gained about 6%, according to data from VettaFi.

“This is a market with thousands of stocks, relatively shallow analyst coverage that focuses on the largest capitalization companies and a lot of nuance, all of which favors active stock picking,” said Philip Wool, one of the portfolio managers Rayliant for the new ETF. .

Case in point: Japan Eyewear Holdings Co., one of several domestic companies that Wool and his colleagues believe could be poised to grow quietly in response to a strengthening yen and improving consumer sentiment.

Analysts and market strategists agreed that these factors could once again generate higher returns for Japanese stocks.

For most of the past 18 months, Japanese indices have climbed to new highs as the yen slipped and corporate governance reforms led to higher dividends and buybacks. Daiki Hayashi, head of sales and marketing for Japan at JP Morgan in Tokyo, said the focus is now shifting to individual stocks instead of market indices. Managers are finding stocks they believe are poised to rise faster and outperform benchmarks, typical behavior in a prolonged bull market, investors and market analysts said.

“Active investors can thrive by looking for those idiosyncratic growth opportunities,” Wool added. “Smaller Japanese stocks have done particularly well in recent weeks.”

In a potential headache for investors, actively managed ETFs tend to incur higher fees than index funds. Rayliant charges a 0.72% fee on its fund, while the Matthews Asia ETF has a 0.79% fee. Meanwhile, the iShares Japan index fund has a fee of 0.50%.

WisdomTree Investments (NYSE: ) still prefers to offer index-based ETFs, but is building its own quantitative benchmarks that focus on value items, said Jeremy Schwartz, the firm’s global chief investment officer. This allows for a degree of customization without allowing for subjective decision-making by portfolio managers, he said.

The $83 million WisdomTree Japan Hedged SmallCap Equity Fund has attracted inflows of $23 million over the past six months and is up 11.23 percent so far this year.

“Recent currency volatility has brought a lot of near-term uncertainty,” Schwartz said. “Every time a market goes straight up for two years or so, and then crashes, people worry if they missed the opportunity. But this is a five to seven year opportunity and we are still early in the game. ”