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Investing in Japan Has Some Risks

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Currency risk

Currency risk is an important factor to keep in mind if you invest in an ETF that holds foreign stocks. In Japan, the falling yen has helped stocks of exporters such as Toyota (TM), Sony (SNE), and Canon (CAJ). It has also helped the Japanese government, since corporate taxes have increased due to a rise in profits.

According to Japan’s Ministry of Finance, Japanese corporations had ordinary profits of 10.4 trillion yen from July–September of 2012. From October–December of 2014, the period with the latest quarterly data available, these profits increased to 18.1 trillion yen after receiving a boost from the falling yen.

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The falling yen

A falling yen is negative for investors. Even though the ETFs mentioned in this series are denominated in dollars, the underlying stocks are bought and sold in yen. So it’s a smart strategy to hedge your investment against currency risk until you’re sure of the direction the currency is taking.

Investors don’t necessarily need to worry about hedging strategies for their Japanese investments. There are ETFs available that automatically hedge the investment for currency movements. One of those ETFs is the WisdomTree Japan Hedged Equity ETF (DXJ).

But perhaps the impact of currency movements is best explained by looking at the hedged and unhedged version of the same ETF. The iShares MSCI Japan ETF (EWJ) has returned ~17% in the past one year. Its currency-hedged version, the iShares Currency Hedged MSCI Japan ETF (HEWJ), has returned 36.5% in the same period.

The broader-based iShares MSCI EAFE (EFA) has returned 1.6% in the last one year. Its currency-hedged version, the iShares Currency Hedged MSCI EAFE (HEFA), returned 14.4% in the same period.

Other risks

As we’ve already seen in this series, the April 2014 sales tax hike in Japan severely affected Japanese markets. Japan plans to hike the tax to 10% in April 2017, which may again impact Japanese markets.

On April 30, the Bank of Japan reduced its projection for core CPI (Consumer Price Index) to 0.8% for fiscal year 2015 from the 1.0% projected in January. It also reduced fiscal year 2015’s growth forecast to 2.0% from 2.1% projected in January.

As you can see, Japan is not a sure thing as far as investments go. But neither is any other investment at this stage of macroeconomic uncertainty.

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