New ETFs look for quality in Japan

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

Patricia Oey 17 November, 2015 | 6:00PM

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 a cumulative 120% (in yen), significantly outperforming the gains of 60% and 19%, respectively, for the S&P 500 and the S&P/TSX Composite Index 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.

The Japanese government has launched a number of initiatives to try to bring Japan's corporate governance practices to be more in line with global standards. In 2014, the government unveiled its Stewardship Code, a set of guidelines for how institutional investors can more effectively engage with company management to focus on medium- and long-term growth. The following year, the government addressed the issue on the corporate side with the launch of the Corporate Governance Code, which pushes for better transparency and more independent board members.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Sony Corp ADR62.97 USD1.27

About Author

Patricia Oey

Patricia Oey  Patricia Oey is a senior manager research analyst for Morningstar.