What are we looking for?
How Japanese stock funds are faring this year.
The Nikkei 225 index has surged nearly 20 per cent this year on optimism about a recovering U.S. economy, and more stability in Europe's financial system.
We looked at the year-to-date returns of Japanese equity funds to March 29. U.S. dollar and duplicate versions of funds were excluded.
What did we find?
The iShares Japan Fundamental exchange-traded fund leading the pack by a wide margin.
This ETF, formerly known as Claymore Japan Fundamental ETF, gained 18.2 per cent. It does not track the Nikkei or MSCI Japan, but an index whose companies are weighted by fundamental factors such as cash flow and dividends.
Hedging its foreign currency exposure to the Canadian dollar has also helped the iShares ETF's robust gains. However, a closer look indicates this fund has merely regained most of what it lost last year.
Mackenzie Focus Japan Class, which was the best relative performer in 2011 with a 5.7-per-cent loss, is in the middle of the pack this year with a 6.8-per-cent return. This mutual fund is only about 20 per cent hedged.
The rebounding Japanese market has been lifted by major exporting companies benefiting from a recovering U.S. economy, and a weakening yen driven by Japan's recent bond-purchase programs.
"Japan has historically been a leader when the global economy is recovering," said Mark Grammer, a portfolio manager who runs the Japan fund at Mackenzie Financial Corp. "Any growth in Japan is dependent on the export side of things."
Like other markets, it's the "more risky names, whether you are in Japan, United States, or Europe, that have led the better performance," Mr. Grammer said. He owns "more defensive, or high-quality names," such as camera giant Canon Inc., and brewery giant Asahi Group Holdings Inc.
It may be difficult for the Japanese stock market to climb higher unless the yen continues to weaken, while rising energy imports could hurt corporate profits and share prices, he suggested. "The issue that Japan has to deal with is power. They have shut down virtually all of their nuclear power plants [since last year's nuclear disaster]"
The market over the long term "may not be the most attractive in the world," he warned. "They still have a significantly aging population, and a very high debt to GDP [ratio]that is growing."