AAXJ: iShares MSCI All Country Asia ex Japan ETF

AAXJ: iShares MSCI All Country Asia ex Japan ETF

The iShares MSCI All Country Asia ex Japan Index Fund (NASDAQ: AAXJ) seeks to replicate the price and yield performance, before fees and expenses, of the MSCI All Country Asia ex Japan Index, or the underlying index. This investment is structured as an exchange-traded fund, or ETF.

The underlying index is composed of the stocks of firms in emerging market Asian countries. This means AAXJ notably excludes Japan, which is the most developed economy in Asia. Specifically, AAXJ focuses on the following countries: China, India, the Philippines, South Korea, Taiwan, Hong Kong, Singapore, Malaysia, Indonesia and Thailand. Notable missing countries include Australia and New Zealand, which means the fund misses total Asia Pacific investment exposure.

Asian markets carry better potential for out-performance than North American or European regions. This is because there tend to be larger gaps between gainers and losers, largely as a result of the disrupting pressure of ongoing globalization and industrialization.

How It Tracks It

AAJX is a passively managed ETF, which means the fund company is willing to accept market fluctuations affecting the index portfolio without much micro-management. There are two major benefits to a passive strategy. First, less management activity helps keep down fund costs. Second, it prevents the fund from mistiming the market when it exits and enters its positions.

This fund uses a capitalization-weighted approach, which has the effect of concentrating much of its assets in China, South Korea and Taiwan. These three countries account for 60% of total capitalization, a number that grows to 72% if you include Hong Kong. Such heavy tilts toward Taiwan and South Korea provide a large boost to technology exposure. There are more than 600 holdings in the portfolio.

In fact, technology and financial services stocks account for more than half of the entire AAJX portfolio. No other sector accounts for even 9% of total assets. The fund is also highly concentrated in giant caps at 59% of assets and large caps at 32%, with only a pittance devoted toward medium-cap stocks.

Even though AAJX is exposed to more developing markets than developed markets, the portfolio is divided almost evenly between emerging market stocks and developed stocks. The biggest individual holdings are also fairly evenly split between the two.

Top ten stocks include Samsung Electrics at 3.65%; Taiwan Semiconductor Manufacturing at 3.28%; Tencent Holdings at 3.11%; China Mobile at 2.66%; AIA Group at 2.38%; China Construction Bank Corp. at 2.21%; Industrial and Commercial Bank of China at 1.63%; Bank of China, Ltd. at 1.38%; CK Hutchinson Holdings at 1.24%; and Hon Hai Precision Industry Co., Ltd. at 1.18%.

Management

All iShares series ETFs are offered in conjunction with BlackRock, the largest provider of ETFs in the world. iShares funds account for greater than 40% of the entire U.S. ETF market. This particular iShares fund invests at least 90% of its assets in the same securities held by the underlying index or in depositary receipts representing securities of the underlying index.

Characteristics

AAXJ is perplexingly expensive at 67 basis points, or 0.67% expense ratio. iShares is not known as the cheapest fund series, but it normally errs on the side of affordability. Moreover, AAJX has a very vanilla investing strategy; nothing about passive Asia exposure suggests expenses should be this high. The category average for such funds, passive or active, is only 0.53%.

Tracking is otherwise efficient compared to the index; the only lag seems to be a result of the administrative fees. Liquidity is strong around $35 million, sometimes as high as $90 million, in daily volume. Net assets approach $3 billion so there in no risk of closure. AAJX is exceedingly tradable for retail or block movers. Spreads rarely exceed 0.02%.

Suitability and Recommendations

AAXJ is probably the first ETF an investor should consider if he is looking for Asian market exposure without the influence of giant Japanese companies. Aggressive small-cap investors do not find much to like with this fund but otherwise it is stable, liquid and diversified.

As with all equity products, AAJX carries market risks and regulatory risks. As an international-focused equity ETF, the fund has added currency risk and emerging market risks.

Asian equity markets tend not to correlate very closely with U.S. equity markets, so investors could use AAJX as a complement to a U.S.-heavy portfolio. It is a decent option for any long-term investment portfolio, unless you are deeply committed to avoiding large fund expenses. Overall, however, AAJX might be best-suited for those with shorter time horizons or a more active trading profile. Use this fund to take advantage of fluctuations in Asian markets. It is available for commission-free trading on TD Ameritrade and Fidelity platforms.

Management is not the calling card of AAJX. Along with high expenses, the fund has a trailing 60-month beta of 0.97, which is about average volatility, and an alpha of -2.22, which is below average for the category. The three-year Sharpe ratio is only 0.51. However, passive ETFs are rarely the best fits for those who stress management.

How a Financial Adviser Client Could Use This ETF

AAJX is not the first ETF an adviser should recommend for most client portfolios. There are better equity funds available and, in most cases, ignoring Japan is no longer the savvy strategy it was in prior decades. Instead, AAJX makes the most sense as a shorter-term play if big returns from emerging Asian markets appear on the horizon.

Such a strategy fits AAJX for two reasons. Not only is the fund very tradable and stable, but Japan's economy is developed enough that it seems less likely to participate in a huge regional jump than its emerging neighbors.

Main Competitors and Alternatives

AAJX is the only ETF to track the MSCI AC Asia ex Japan Index, but there are several alternatives for investors who want non-Japanese exposure to Asia.

For growth-oriented investors, the iShares MSCI All Country Asia ex Japan Small-Cap ETF was posed as an aggressive alternative to AAJX. However, the board of trustees of the iShares Trust voted to close and liquidate this fund and distribute proceeds to shareholders as of August 28, 2015. Instead, small-cap investors might have turn to country-specific funds such as the MSCI Singapore Small-Cap ETF.