This article was originally published on ETFTrends.com.
Lately, the land of the rising sun has been the land of the falling yen. While single-country equity exposure to Japan has provided investors with relative outperformance year-to-date (YTD), they appear to be better off shedding the currency drag. That strategy is more enticing given the yen has been mired in a 40-year low recently.
It’s a phenomenon known as the international investor’s paradox, which is the desire to capture overseas equity growth and portfolio diversification. However, it comes paired with the volatility tied to foreign exchange (FX) fluctuations. In essence, unhedged international investing forces individuals to make two distinct bets—one on the underlying corporate fundamentals, and another on the direction of a foreign currency relative to the U.S. dollar (USD). There’s an easier solution to this: currency-hedged ETFs.
Key Takeaways:
-
Unhedged international investing forces individuals to make two distinct bets—one on localized corporate fundamentals and another on the direction of foreign currencies relative to the U.S. dollar.
-
Japan’s export-driven economic renaissance benefits from a weaker yen, but this currency drag dilutes returns for unhedged investors unless they utilize currency-hedged strategies.
-
Because major domestic U.S. indexes are already heavily exposed to a weakening dollar through multi-national revenue streams, adding unhedged international equities simply doubles down on that existing currency risk.
See More: Japan’s Record Run: The Land of the Rising Returns
Japan’s Economic Renaissance
Japan’s economic renaissance is fundamentally an export-driven story. Based on the International Monetary Fund (IMF), Japan is the fourth-largest economy in the world though its corporate engine doesn’t derive its fuel from spending by the domestic consumer. Instead, it relies on international buyers purchasing Japanese goods, which creates an economic inverse relationship: a lower yen directly fuels accelerating corporate earnings and export volumes.
At the same time, major corporate governance shifts are compounding Japan’s appeal. The Tokyo Stock Exchange (TSE) recently initiated its most aggressive overhaul in 60 years, demanding that companies with low price-to-book (P/B) ratios disclose explicit initiatives for improving valuations. In response, corporations sought to increase shareholder value by hiking dividends and buybacks.
Japan is also in good graces with Warren Buffett, whose Berkshire Hathaway firm recently increased its stakes to nearly 10% across five major Japanese trading firms. With discounted forward price-to-earnings multiples, the country’s equities make for a compelling value-oriented choice.
