Investing in international markets has become a cornerstone of modern portfolio diversification, and for investors in Japan, foreign index funds provide a simple, efficient way to gain exposure to global markets. Foreign index funds, particularly exchange-traded funds (ETFs) and mutual funds, track the performance of foreign stock indices and offer a straightforward method of investing in international equities without the need to select individual foreign stocks. This article explores the benefits, types, and key considerations for Japanese investors looking to invest in foreign index funds, along with an analysis of the best options available.

What Are Foreign Index Funds?

Foreign index funds are investment vehicles that track the performance of stock market indices from countries outside of Japan. These funds are designed to mimic the performance of the underlying index by investing in the same stocks that comprise that index. For example, a foreign index fund tracking the S&P 500 would invest in the same 500 companies listed on that index.

These funds come in two main forms: Exchange-Traded Funds (ETFs) and Mutual Funds. Both allow Japanese investors to access global equities, but ETFs are more commonly traded on public exchanges and tend to be more liquid, while mutual funds might be structured for more long-term investments with lower fees.

Why Invest in Foreign Index Funds in Japan?

The primary appeal of foreign index funds lies in their ability to offer investors exposure to global markets without requiring them to pick individual foreign stocks. Here are some reasons why Japanese investors should consider investing in these funds:

1. Diversification: By investing in foreign index funds, Japanese investors can diversify their portfolios internationally. This reduces the risk of being overly exposed to the fluctuations of the domestic market. Global diversification can help spread risk across multiple countries and regions, making the portfolio less dependent on the performance of Japan’s economy.

2. Access to High-Growth Markets: Foreign index funds often provide access to high-growth markets in the United States, Europe, and emerging economies. For instance, the U.S. is home to some of the world’s largest and most innovative companies, which can significantly enhance the growth potential of an investor’s portfolio.

3. Cost Efficiency: Compared to actively managed funds, foreign index funds tend to have lower expense ratios. Index funds aim to replicate the performance of the market index rather than trying to beat it, which results in lower management costs. This can help investors keep more of their returns over the long term.

4. Ease of Investment: For Japanese investors, foreign index funds are a convenient way to invest internationally. Rather than dealing with the complexities of buying foreign stocks directly, investors can gain broad exposure to foreign markets by purchasing shares of these funds through local brokers or financial institutions.

5. Currency Diversification: Investing in foreign index funds allows Japanese investors to diversify their currency exposure. Since these funds invest in markets outside Japan, their assets are denominated in foreign currencies, which helps investors hedge against potential JPY depreciation. This could be particularly beneficial during periods of yen weakness.

Types of Foreign Index Funds Available to Japanese Investors

​Japanese asset management companies offer a variety of foreign index funds, enabling investors to diversify their portfolios internationally. These funds track various global indices and are accessible through the Tokyo Stock Exchange (TSE). Below are some notable examples:​

1. NEXT FUNDS MSCI-Kokusai Index ETF (Ticker: 2514)

Managed by Nomura Asset Management, this ETF tracks the MSCI-Kokusai Index, which includes non-Japanese developed market equities. It provides Japanese investors with exposure to a broad range of international stocks from developed countries, excluding Japan. The fund is listed on the TSE and is denominated in Japanese Yen.​

2. Daiwa ETF MSCI ACWI ex Japan (Ticker: 2559)

Offered by Daiwa Asset Management, this ETF aims to replicate the performance of the MSCI All Country World Index excluding Japan. It encompasses both developed and emerging market equities, providing comprehensive global exposure. The fund is traded on the TSE in Japanese Yen.​

3. Nikko Listed Index Fund US Equity (S&P 500) No Currency Hedge (Ticker: 1547)

Managed by Nikko Asset Management, this ETF seeks to track the S&P 500 Index, representing large-cap U.S. equities. It offers Japanese investors access to the U.S. stock market without currency hedging, meaning returns are subject to fluctuations in the USD/JPY exchange rate. The fund is listed on the TSE.​

4. iShares Core MSCI Emerging Markets ETF (Ticker: 1582)

Offered by BlackRock Japan, this ETF tracks the MSCI Emerging Markets Index, providing exposure to large and mid-cap equities across emerging market countries. It allows Japanese investors to tap into the growth potential of emerging economies. The fund is traded on the TSE and is denominated in Japanese Yen.​

Considerations for Japanese Investors in Foreign Index Funds

While foreign index funds offer significant benefits, Japanese investors should be aware of a few key considerations before investing in these funds:

1. Currency Risk

Investing in foreign index funds exposes Japanese investors to currency risk. Since these funds invest in foreign markets, the value of the fund is influenced not only by the performance of the underlying companies but also by fluctuations in currency exchange rates. For example, if the U.S. dollar strengthens against the yen, the value of U.S.-denominated assets could rise for Japanese investors. However, if the yen strengthens, the returns from foreign index funds could decrease due to the adverse effect of currency fluctuations.

To mitigate currency risk, some Japanese investors may opt for currency-hedged ETFs, which aim to neutralize the impact of currency fluctuations between the yen and the foreign currencies of the underlying assets.

2. Tax Implications

Japanese investors should be aware of the tax implications associated with investing in foreign index funds. Dividends from foreign funds may be subject to withholding taxes in the country of origin, and Japanese tax residents may need to report and pay taxes on their foreign investment income. However, Japan has tax treaties with many countries that can reduce or eliminate withholding taxes on dividends.

3. Access to Foreign Funds

While many global index funds are available to Japanese investors, some may only be accessible through foreign brokerage platforms. Japanese investors should ensure that their local brokerage firms offer the ability to trade international ETFs and mutual funds. Many large brokers in Japan do offer access to foreign ETFs listed on major international exchanges like the NYSE or LSE, but it’s essential to verify this before proceeding with an investment.

4. Fees and Expense Ratios

As with any investment, Japanese investors should carefully compare the fees and expense ratios of foreign index funds. While index funds are generally more cost-effective than actively managed funds, the fees can vary. Lower expense ratios can help maximize long-term returns, so it’s advisable to select funds with competitive costs.

5. Fund Liquidity

Liquidity is another important consideration when selecting foreign index funds. Funds with higher liquidity allow for easier buying and selling without significant price discrepancies. Japanese investors should opt for funds with substantial trading volumes to ensure they can enter and exit positions efficiently.

Conclusion

Foreign index funds provide an excellent opportunity for Japanese investors to diversify their portfolios and gain exposure to international markets. Whether investing in developed economies like the U.S. and Europe or emerging markets in Asia and Latin America, foreign index funds offer a low-cost, diversified, and efficient way to tap into global growth. However, investors should carefully consider factors like currency risk, tax implications, and fees before investing in these funds.

For Japanese investors looking to build a globally diversified portfolio, foreign index funds present a compelling investment option that can complement their domestic holdings and enhance long-term growth potential. By selecting the right foreign index fund and managing the associated risks, investors can benefit from exposure to the world’s leading markets while maintaining a balanced and diversified portfolio.