Vanguard FTSE Japan ETF: July 2024 update

• Vanguard is a pioneer in index investing and launched its first ETF in 2001

• This ETF offers exposure to a broad range of companies in Japan

• Its low charge should help it track the FTSE Japan Index closely

How it fits in a portfolio

An ETF is a basket of investments that often includes company shares or bonds. They tend to track the performance of an index such as the FTSE Japan Index and trade on stock exchanges, like shares. This means their price fluctuates throughout the day.

The Vanguard FTSE Japan ETF provides a low-cost option for tracking the performance of the FTSE Japan Index. It invests in a range of large and medium-sized Japanese companies across a variety of sectors.

An ETF is one of the simplest ways to invest and can be a low-cost starting point for an investment portfolio aiming to deliver long-term growth. ETFs that track the Japanese market could be used to diversify a portfolio that’s focused on other areas like the US and Europe.

Manager

Vanguard is a pioneer when it comes to passive investing, having created the first retail index fund over 45 years ago. It now runs some of the largest index funds in the world. Given its size, it has a big investment team with the expertise and resources to track indices and markets as closely as possible, while having scale to keep costs down.

Vanguard ETFs are run by a large, global team. They’re spread across three investment hubs around the world – the US, UK and Australia. This team-based approach means there’s no named manager on the ETF. As a collective team, Vanguard has run this ETF for 11 years.

Vanguard also has a trading analytics team, which is responsible for ensuring the ETFs buy and sell investments efficiently and at a competitive cost. This involves analysing data from different brokers and banks. Lower costs should help the ETFs track their benchmarks as tightly as possible.

Process

This ETF aims to track the performance of the FTSE Japan Index, which includes around 500 companies. It does this by investing in all the underlying companies of the index, and in line with each company’s index weight. This is known as full replication and can help the ETF track the index closely.

The ETF has a large amount invested in the industrials and consumer discretionary sectors which make up 25.9% and 22.2% of the fund respectively. Other key sectors include financials and technology.

Reducing costs is a key part of keeping the tracking difference between the ETF and the benchmark to a minimum. In any ETF, factors like taxes, dealing commissions and spreads, and the cost of running the ETF all drag on performance. To help keep these costs down, the team aims to make large investments in companies instead of lots of small transactions.

Vanguard will also lend some of the investments in the ETF to other providers in exchange for a fee, which can be used to offset some of the costs. They will only lend securities to a limited number of high-quality approved dealers. They indemnify the fund against any loss from this process, meaning there should be no negative impact on investors. However, stock lending is a higher risk approach.

As this ETF is listed offshore investors are not usually entitled to compensation from the UK Financial Services Compensation Scheme.

Culture

Vanguard is currently the second largest asset manager in the world and runs around $8.6trn of assets globally as of March 2024. The group aims to put the client at the forefront of everything it does, which drives its focus on quality, low-cost index products.

John Bogle, known as Jack, founded Vanguard in 1975 and it’s owned by investors. This allows Vanguard to redirect its profits back to investors in the form of lower fees, instead of paying dividends to external shareholders. Bogle believed in creating products that simply track the performance of a market rather than taking a shot at picking individual companies which may beat them.

The team running this ETF works closely with other equity research and risk departments across the business. They have daily and weekly meetings to discuss ongoing strategy which could add good support and challenge on how to run the ETF effectively.

ESG Integration

Vanguard is predominantly a passive fund house. While it has offered exclusions-based passive funds for many years, it has lagged peers in offering passive funds that explicitly integrate Environmental, Social and Governance (ESG) criteria by tracking indices that tilt towards companies with positive ESG characteristics, and away from those that don’t.

Vanguard’s Investment Stewardship team carries out most of the firm’s voting and engagement activity. Their stewardship activity is grounded in the firm’s four principles of good governance: board composition and effectiveness, oversight of strategy and risk, executive compensation and shareholder rights. The Stewardship team produces frequent insights on their engagement activity at both a corporate and governmental level.

Vanguard courted controversy in 2022 when it left the Net Zero Asset Managers’ Initiative, a group of asset managers that have committed to achieving net zero carbon emissions by 2050. It claimed its decision would improve clarity for investors and allow it to speak independently. We view this as a disappointing backward step, but we’re encouraged that they will continue to engage with companies on climate-related issues.

The Vanguard FTSE Japan ETF tracks an index that does not specifically integrate ESG considerations into its process. The ETF can therefore invest in shares issued by companies in any sector.

Cost

The ETF currently has an ongoing annual fund charge of 0.15%. The annual charge to hold ETFs in the HL ISA or SIPP is 0.45% (capped at £45 p.a. in the ISA and £200 in the SIPP). There are no charges from HL to hold ETFs within the HL Fund and Share Account or HL Junior ISA. Ensuring an ETF has a low charge is an important part of tracking the underlying index closely.

As ETFs trade like shares, both a buy and sell instruction will be subject to the HL share dealing charges.

Performance

Since launch in May 2013, the ETF has done a good job of tracking the FTSE Japan Index, returning 105.30%* during this time. As expected from an ETF, it’s lagged the benchmark over the long term because of the costs involved. However, the tools used by the managers have helped to keep performance as tight to the index as possible. Remember, past performance isn’t a guide to the future.

Over the past 12 months, the ETF has tracked the performance of the index closely, rising 12.80%. Oil & Gas companies were the best performing during the year with the energy sector growing 54.97%. However, this sector only makes up a very small part of the total index so doesn’t have a significant impact on overall performance.

The financials sector returned 49.80% and contributed the most to the ETF’s performance over the year, followed by industrials which make up the largest portion of the index. On the other hand, the health care sector was the biggest detractor from performance and returned -4.71% over the same period.

One of the key events in Japan during the year was when the Bank of Japan ended eight years of negative interest rates and raised rates for the first time since 2007. This was a significant move as Japan became the last country in the world to end negative interest rates and reflects changes in the Japanese economy as it moves out of a long-term deflationary slump.

Japan’s main stock market passed its all-time high after 34 years. This was driven by increased foreign investment into Japanese companies due to strong corporate profits, a falling yen and ongoing corporate governance reforms. A weaker yen makes Japanese goods more attractive to overseas buyers, which has benefited companies that export more of their goods abroad like Toyota, one of the world's largest automakers and Japan’s biggest company by market value.

Given Vanguard’s size, experience and expertise running ETFs, this ETF should continue to track the index well in future, though there are no guarantees.