The Top 4 ETFs to Track the Nikkei or Approximate Many of Its Holdings for 2016

The Top 4 ETFs to Track the Nikkei or Approximate Many of Its Holdings for 2016

The Nikkei 225, more commonly known as the Nikkei Index, is one of the most famous and longest-running stock indexes in Asia. Tracked daily by the Nihon Keizai newspaper since 1950, it follows a custom batch of the largest Japanese stocks listed on the Tokyo Stock Exchange. The exchange grew a record 56.72% in 2013 and was positive again in 2014 as the Japanese economy threatens steady growth for the first time in decades.

For exchange-traded fund (ETF) investors, pickings for the Nikkei are slim. Very few ETFs available to American investors actually follow the Nikkei directly, and most others in the Japanese large-cap space are small and poorly traded.

Returns in the United States are uncertain heading into 2016. The Federal Reserve is likely to raise interest rates, and the European Union may be headed for a slump. Investors are looking for a different investment environment. The following are four ETFs to consider for those looking at Japan as a possible equity haven.

MAXIS Nikkei 225 ETF

Issuer: Precidian Investments

Assets Under Management (AUM): $48.6 million

2015 Year-to-Date (YTD) Performance: 13.85%

Expense Ratio: 0.50%

The only moderately trade-worthy ETF in the United States that tracks the Nikkei 225 Index directly, the MAXIS Nikkei 225 Index ETF (NYSEARCA: NKY) offers shareholders a balanced exposure to firms listed on the Tokyo Stock Exchange. This gives it a unique place in a narrow, Nikkei-based subsector, but NKY is not nearly as efficient or liquid as some other Japanese equity ETFs.

NKY is not a huge fund, so investors should seriously balance the risk of closure despite more than four years of trading. Costs are high for a relatively passive ETF at 50 basis points (bps). Daily volume is respectable for individual traders, but market makers might struggle to deal with the huge 500,000-share creation units.

The Nikkei is a stock-price-weighted index, which in Japan means a lot of exposure to major industrial and retail stocks. American investors will recognize major holdings such as Kyocera and Honda. Other well-represented sectors include technology and health care.

Roughly half of the fund's 225 holdings are giant- or large-cap stocks, but there is plenty of mid-cap and small-cap exposure as well. NKY's blended portfolio adds excellent sector diversification, but investors should be advised not to rely too heavily on a Japanese economy that has experienced modest or low growth since the 1990s. That said, the fund's annualized growth between November 2012 and November 2015 exceeds 13%, and prospects for 2016 look promising.

iShares MSCI Japan ETF

Issuer: BlackRock iShares

AUM: $20.61 billion

2015 YTD Performance: 12.13%

Expense Ratio: 0.48%

The super-massive iShares MSCI Japan ETF (NYSEARCA: EWJ), often dubbed "the Japan ETF," is a reliable fund with nearly 20 years of performance spanning multiple expansions and recessions in the Japanese economy. With a $20 billion-plus asset base behind it and greater than $450 million in daily volume, EWJ is far larger and more liquid than any competing Japan-centric ETF.

EWJ does not actually follow the Nikkei Index; it tracks the MSCI Japan Index and holds more than 300 stocks, so it falls behind NKY on this list. However, there is plenty of crossover between the two portfolios and, in many ways, EWJ is the safer play.

EWJ's portfolio is larger than NKY's, and its weighted average holding boasts a market capitalization nearly 40% higher; the index drops the smallest 15% of listed Japanese companies. Combine that with a longer track record and significantly more AUM, and EWJ is probably the preferred ETF for conservative investors.

All-in costs are moderate and very much in line with other Asian ETFs. Dividends are slight, so income investors may be tempted to look at the $17 billion WisdomTree Japan Hedged Equity ETF instead.

iShares Japan Large-Cap ETF

Issuer: BlackRock iShares

AUM: $105.48 million

2015 YTD Performance: 5.07%

Expense Ratio: 0.50%

The MAXIS Nikkei 225 ETF includes a lot of small- and mid-cap exposure, so investors looking for a true large-cap Japan ETF should consider the iShares S&P/TOPIX 150 ETF (NYSEARCA: ITF). ITF tracks a committee-selected index of 150 of the largest companies listed on the Tokyo Stock Exchange. With a weighted average market cap of $46.77 billion as of November 2015, ITF's standard holding is almost twice as large as NKY's.

Still, ITF does not track the Nikkei in any pure sense, and its larger tilt means less potential upside than its rival. This bore out during 2015, when ITF realized less than half the gains of NKY. Spreads are also significantly worse than NKY's, even considering its smallish asset base, so traders should tread cautiously. Creation units are 300,000 shares, smaller than NKY's 500,000 shares, but still very large and unfriendly to market makers.

Top holdings are unsurprising for a large-cap Japanese ETF. Major stocks include Honda, Mitsubishi, Toyota and UFG. For all of its other potential challenges, ITF tracks its index very well and shows very little sector bias compared to the broader Japanese market.

Deutsche X-trackers MSCI Japan Hedged Equity ETF

Issuer: Deutsche Bank

AUM: $1.92 billion

2015 YTD Performance: 14.39%

Expense Ratio: 0.45%

The Deutsche X-trackers MSCI Japan Currency Hedged Equity ETF (NYSEARCA: DBJP) follows a currency-hedged version of EWJ's MSCI Japan Index, except that DBJP effectively cancels out the hedge of its index through direct investment in underlying Japanese stocks.

Getting rid of the hedging element of the index creates a traditional ETF feel, and DBJP shareholders do not have to put up with the dual concerns of portfolio performance and movements in the Japanese yen. Oddly enough, DBJP is a cheaper fund than EWJ, despite the added complication associated with adding and removing currency hedging. For pure buy-and-hold, cost-sensitive investors, DBJP might actually be a better alternative, albeit by only three basis points. At nearly $2 billion in managed assets, there is little risk of closure and spreads are thin.

The resulting portfolio looks and acts a lot like EWJ. The major sector exposure includes industrials, consumer cyclicals and financials, with proportions very similar to the segment trendsetter. There are slight tilts in the underlying index that favor large caps, but DBJP still manages to follow more than 80% of the Tokyo Stock Exchange.