Another QE Catalyst For Yen Hedged ETFs Could Be Lurking

Up until 2013, the iShares MSCI Japan ETF EWJ was the household name among Japan exchange traded funds. Then along came Prime Minister Shinzo Abe, Bank of Japan Governor Haruhiko Kuroda and their weak yen policies aimed at bolstering Asia's second-largest economy.

Now, it is fair to say that in terms of brand recognition, the WisdomTree Japan Hedged Equity Fund DXJ is the Coca-Cola of Japan ETFs. The Deutsche X-trackers MSCI Japan Hedged Equity ETF DBJP is no slouch, either. A few years ago, DBJP was nearly unheard hear of among Japan ETFs. Today, it is a $1.3 billion ETF. And it has taken the iShares Currency Hedged MSCI Japan ETF HEWJ less than 20 months of trading to amass more than $865 million in assets.

BOJ has engaged in one of the largest quantitative easing schemes of any central bank. The central bank's current asset-purchasing program is valued at 80 trillion yen and Japan's interest rates are zero percent, or by the estimates of some economists, negative in real terms. Those factors would seemingly make more potentially yen-depressing QE unlikely, but some analysts see more, not less, Japanese QE on the way.

“The Bank of Japan will need to ease again on Oct. 30 by increasing the size of QQE by JPY10 trillion to JPY90 trillion,” according to Standard Chartered.

Energy prices remaining lower for longer than expected (Japan is a net oil importer) and diminishing concerns that BOJ's buying of Japanese government bonds could cause a liquidity event in Japan's bond market bolster the case for additional QE, notes Standard Chartered.

If Standard Chartered's assessment proves accurate, that could be good news for ETFs like DXJ. As it is, DXJ has added over $4.6 billion in new assets this year, a total surpassed by just five other ETFs. Investors have plowed $655.2 million and $555.1 million, respectively, into DBJP and HEWJ since the start of the year.

However, investors in these ETFs should not get carried away with the idea of more BOJ QE. Kuroda recently said BOJ does not need to launch additional QE and that the current policy is having the desired impact of lifting inflation.

Rather than more QE, the outcome that appears more probable is Abe pushing forward with more pro-growth policies aimed at stimulating Japan's domestic economy.

“Specifically, all decision makers acknowledged that the recent drop in Japanese stocks was not just due to an external Greece and China 'risk off' but that the sell-off was caused in part by the slip in Abe’s popularity. This candor is very encouraging,” according to a recent WisdomTree note. “More fundamentally, Abe’s policy team knows that positive wealth effects from both the stock market and the real estate market are a necessary condition for a true Japan revival.”

Policies aimed at stimulating Japan's internal economy, if proven effective, could be a boon for the WisdomTree Japan Hedged SmallCap Equity Fund DXJS. An easy of way describing the WisdomTree Japan Hedged SmallCap Equity Fund is that it is the small-cap counterpart to DXJ.

Just over two years old, DXJS is home to $207 million in assets, nearly $84 million of which have come into the fund this year. DXJS allocates almost 49 percent of its combined weight to industrial and consumer discretionary names, levering the ETF to the weak yen theme and an ongoing recovery in Japan's domestic economy.