Japanese Stocks Are Trouncing the S&P 500. Consider These 5 Funds.

An unprecedented ¥21.28 billion ($149 million) in dividends was returned by the 225 companies in the Nikkei Stock Average in the fiscal year that ended in March, while share buybacks ballooned to a record ¥8 trillion over the same period, according to Dow Jones Market Data. The levels are pint-size compared with the U.S., where

S&P 500

companies paid out $557.83 billion in dividends and made share buybacks totaling $933.15 billion in 2022, but they have grown significantly in the past two years. Dividends have grown 51% since 2021 while buybacks have more than doubled.

And investors have reason to hope the trend will continue.

Honda Motor

(7267: JP) has decided to pay a record ¥150 a share in the year ending March 2024. Citizen Watch (7762: JP) earlier this year said it would buy back nearly 26% of its shares by mid February, implying a buyback program worth ¥65.59 billion, the largest ever for a Japanese fiscal year, though

Mitsubishi UFJ Financial Group

(8306: JP), Japan’s largest lender, has paused repurchases citing uncertainty about bankruptcies worldwide.

Buybacks and dividends typically boost share prices—Honda Motor stock was up 45% in the first half of this year, while Citizen gained 46%—but the people who run Japan’s main stock market are asking for more. Nearly 45% of the companies in the Nikkei Stock Average trade for less than the value of the assets on their books, compared with 5.2% of those in the S&P 500, so the Tokyo Stock Exchange is pressing for change.

It wants companies to boost their price-to-book ratios above one. While ratios below that level are synonymous with stocks that are cheap, they also imply that investors lack confidence about the outlook for growth and profitability. The TSE suggests investing in “research and development and human capital” as one way to improve the ratio. Buying back stock and returning capital through dividends could help as well.

The stock exchange hasn’t set a deadline for compliance, but the specificity of the target, combined with the recent pace of change, has investors excited. Add in a dash of spending from travelers after Japan, one of the last Covid-19 holdouts, opened its doors in October, plus the fact that companies are offering higher wages to workers as prices grow in an economy long plagued by deflation, and you have a rally in one of the world’s largest stock markets.

The Nikkei has gained 27% since the start of the year, compared with 16% for the

S&P 500
.

While it is still about 15% below the record of 38,916 achieved in December 1989, the market appears to be coming back. The index crossed the 33,000 mark this year for the first time in 33 years.

“One could make the argument that there is upside to earnings [and] for higher valuations moving forward,” says Joe Nelesen, senior director for index investment strategy at S&P Dow Jones Indices.

Investors who lack the time or expertise to track individual Japanese stocks can take advantage of potential gains using funds. With the help of Morningstar Direct, Barron’s took a stab at weeding through the 25 U.S-based Japan fund options, screening for those with at least $200 million in assets, low expense ratios and no less than a five-year record. Five that looked appealing include both mutual funds and exchange-traded funds, as well as active and passive investing strategies.

The iShares MSCI Japan ETF (ticker:

EWJ

) is the largest Japan equities fund at $13 billion in assets, with $1.6 billion added in June so far, the biggest monthly net inflow since October 2018. The passive fund, which tracks the benchmark MSCI Japan index, is concentrated in large-cap stocks. Industrial and technology companies such as

Hitachi

(TYO: 6501) and

Sony Group

(TYO: 6758) comprise more than 40% of the ETF. 

BlackRock (BLK), the leader in the ETF industry,…