Should You Invest in Japanese Funds?

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Are you betting on a Japanese recovery? Investors are.

In the two weeks since an earthquake and tsunami ravaged Japan, investors have poured $1.87 billion into exchange-traded funds that track the Japanese stock markets, according to investment research firm TrimTabs. Japan ETFs hold nearly $8.3 billion in total, so we’re talking about a massive trend. (In one single day last week — Thursday, March 24 — $122 million poured in.)

“The earthquake really created a good opportunity for whoever was watching the Japanese stock market trying to find a point of entry,” says Minyi Chen, Asia equity analyst for TrimTabs. “Investors reacted very quickly.”

In other words, when the Nikkei 225 index dropped 20% following the disaster, investors saw a buying opportunity and rushed in. (And currently, according to Chen, most shares of Japan ETFs are held by retail investors rather than institutions.)

Japanese stocks are still down close to 10%. It would take you less than five minutes to pick up some shares of iShares MSCIJapan Index Fund (EWJ) or another Japan ETF via your online brokerage. Should you?

Idle speculation

Hey, how much do you know about Japan? I know a few things myself. For example, I know that you can get luscious shrimp tempura at Daikokuya restaurant in Asakusa, just steps from the Senso-ji temple.

Everything I know about the earthquake and Japan’s prospects for recovery, however, comes from news reports. From a humanitarian point of view, these reports are a mix of horrifying and reassuring. From an investing point of view, however, they are completely worthless. By the time I hear about a development in Japan, a more sophisticated investor has already investigated it, acted on it, and thereby affected the price of the securities I’m thinking about buying.

“Why should you get superior returns just by following the headline news?” says Rick Ferri, founder of Portfolio Solutions and author of The Power of Passive Investing. “The people who are going to be following the headline news and doing trading on it are probably not skilled traders. It’s a couple of guys sitting around in a Starbucks having a cup of coffee, saying, you know, maybe we should buy Japan. So they run out and buy a Japanese fund.”

Yes, some folks have made money flipping Japanese stocks in the past two weeks. “If you simply look at the amount of money going in, you can’t justify that it’s all long-term investors who look for capital gain or steady asset price appreciation,” says Chen.

“If you’ve got somebody who goes out and bets on Japan and they win, are they lucky or skilled?” asks Ferri. “Well, they’re lucky.” Investors who scour the headlines for special buying opportunities lose more often than they win, and they incur heavy trading costs and taxes in the process.

How to bet smartly

It’s worth pointing out that Japan provides the most cautionary tale in the history of stock market investing. In the 1980s, at the height of a real estate bubble, the Nikkei index hit 40,000. Today, the Nikkei stands at about 9,500. Just because a market dips doesn’t mean it has to come back up.

That doesn’t mean investors should avoid Japan. I think (read: hope) that the prospects for a full recovery from the earthquake are excellent. As an investor, however, I know that these prospects are already built into the price of Japanese securities. I have no special knowledge.

There are better ways to invest in Japan than through a country-specific ETF. “For a retail investor, investing in single-country ETFs requires a lot of work, because you need to know all the details about one country and all those companies,” says Patricia Oey, an ETF analyst at Morningstar. “It’s better to invest in a more diversified fund.”

Or listen to legendary Yale endowment manager David Swensen, from his book Unconventional Success: “The proliferation of narrow niche products, including individual country funds and specific sector funds, clutters the ETF landscape with generally irrelevant, often confusing choices.”

Top picks

Say you want to follow Oey’s advice, or Swensen’s, or even, God forbid, mine. What to buy?

Because I have no idea which country’s stock market will perform best in the future and which will stagnate, I want to own all of them. Owning the whole world keeps getting easier and cheaper. If you like ETFs, here are a few to consider. Each of these funds owns the world minus the United States and should therefore be combined with a US equity fund. Because Japan is a big part of the world economy, it’s a big part of these funds.

• Vanguard Total International Stock ETF (VXUS): expense ratio 0.2%. Can be purchased commission-free through Vanguard.
• iShares ACWI ex-US (ACWX): expense ratio 0.35%. Can be purchased commission-free through Fidelity.
• Schwab International Equity (SCHF): expense ratio 0.13%. Can be purchased commission-free through Schwab.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.