WisdomTree

Abenomics, Japan, Japan Sectors

The Process Driving New Japanese Sector ETFs

by Jeremy Schwartz, Director of Research on April 8, 2014

As Abenomics continues to gain traction and Prime Minister Abe makes more progress on his growth strategy for Japan (the “third arrow” of Abenomics), I believe there will be a continual evaluation of the stocks and sectors most primed to benefit from the new government initiatives.

WisdomTree has developed five new Japan Sector Indexes designed to be primary beta benchmarks for some of the major investment themes stemming from Abenomics:

1. Reflation: The stocks included as part of the reflation theme most often include financials and real estate.

2. Abe’s Growth Strategy: There are many areas of Abenomics, but two sectors in particular—health care and technology—have the potential to be beneficiaries of government initiatives to increase economic growth.

3. Yen Sensitivity: The stocks of exporters, such as capital goods companies, have been some of the most sensitive to changes in the yen’s exchange rate.

Below I focus on the methodology and construction for these new indexes.

Investment Process for WisdomTree Japan Sector Indexes

The WisdomTree Japan Sector Indexes use a rules-based process for selecting and weighting securities while hedging exposure to the yen.
 
Selection Rules

o Eligible Universe: Tokyo & JASDAQ stock exchanges

o Market Cap Requirements: Minimum float-adjusted market capitalization1 of US$500 million

o Liquidity Requirements (all criteria measured as of Index screening date):

  • 3-month average daily volume of at least $100,000

  • Calculated volume factor (3-month average daily volume/weight in Index) greater than $200 million

  • At least 250,000 shares traded or a notional value of shares traded of $25 million for each of the last six months
 
Weighting Rules

o Weighting: Float-adjusted market capitalization

o Holding Caps: At Index rebalance dates, individual security weights are capped at 10%2. Between annual Index rebalances, individual security weights may fluctuate above 10% due to market movement.

o Liquidity Adjustment: If a security has a calculated volume factor of less than $400 million, its weight will be reduced proportionally by a liquidity factor that equals the original calculated volume factor/$400 million.
 
Mechanics of the Currency Hedge

o Hedged Equity Return = Local Market Equity Return + Yen Return – Hedged Yen Return
 
Sector Characteristics

Below I highlight key facets of the exposures for each Japan Sector Index to provide insight into some of the primary factors that might influence how these Indexes perform.
 
Top 5 Industry Exposures for the Japan Sector Indexes


For definitions of Indexes in the chart, please see the Glossary.
 
Executing the Desired Exposures through WisdomTree’s Exchange-Traded Funds (ETFs)

WisdomTree has created five Japan Sector ETFs, each designed to track its respective Japan Sector Index after costs, fees and expenses.


 
Conclusion

I believe 2013 marked the start of a multi-year bull market in equities, and I think there is investor demand for more specific executions for Japanese equities. With these new sector ETFs, WisdomTree has expanded the Abenomics tool kit for Japanese investment themes such as reflation, Abe’s growth strategy and yen sensitivity.
 
1Float-adjusted market cap excludes shares held by control groups, public companies and government agencies.
2Securities of brokerage or financial firms that derive 15% or more of their revenue from securities-related activities (referred to as “12(d)(3) securities”) are capped at 4% at the annual rebalance in the WisdomTree Japan Hedged Financials Index.

Important Risks Related to this Article

There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Funds focusing their investments on certain sectors increase their vulnerability to any single economic, regulatory or sector-specific development. This may result in greater share price volatility. The Funds focus their investments in Japan, thereby increasing the impact of events and developments in Japan, which can adversely affect performance. The Funds use various strategies to attempt to minimize the impact of changes in the Japanese yen against the U.S. dollar, which may not be successful. Investments in derivative investments can be volatile, may be less liquid than securities and may be more sensitive to the effect of varied economic conditions. As these Funds can have a high concentration in some issuers, the Funds can be adversely impacted by changes affecting those issuers. Due to the investment strategy of the Funds, they may make higher capital gain distributions than other ETFs. Please read each Fund’s prospectus for specific details regarding each Fund’s risk profile.

Click to see more articles from this category