Include small/midcaps in Japan index fund?

aroominyork

I am finally calling it a day with Lindsell Train Japanese and switching to a Japan index fund. The question is whether to go for Fidelity, which includes about 6.3% in small/midcaps by Morningstar stock style tables, or HSBC (or iShares) which is about 16.5% small/midcaps. I was going to choose the latter to get the small/midcap exposure but then compared their relative performance and, even though Japanese small caps have outperformed the main index by some distance over the last five years, HSBC has underperformed Fidelity. That suggests HSBC does not capture the performance of the small/midcap market for some reasons - what might that be? - so I might as well go for Fidelity. Any thoughts on this?

MX5huggy

They are both tracking the same index the difference is just tracking error. Don’t know why you are finding they are made of different stuff they are the same. Just choose the cheaper (Fidelity) 

maxsteam

... or split the funds between the two if you cannot decide.

soulsaver

Think you are misreading... the blue line is not Fidelity.

aroominyork

MX5huggy said:

They are both tracking the same index the difference is just tracking error. Don’t know why you are finding they are made of different stuff they are the same. Just choose the cheaper (Fidelity) 

Fidelity tracks the MSCI index and has 272 holdings.

HSBC tracks FTSE Japan and has 525 holdings.
As explained above, the Morningstar stock style analysis shows HSBC having significantly more mid/small caps.

https://www.justetf.com/uk/news/etf/msci-vs-ftse-which-etf-provider-is-the-best-index-provider.html explains "MSCI global indices capture 85% of the investable universe by market cap and exclude the bottom 15% as small-cap firms. But FTSE global indices track 90% of market capitalisation and exclude the bottom 10% as small-cap firms. Essentially, FTSE scoops up some companies that MSCI define as small-cap, which explains why FTSE indices usually contain more companies."

aroominyork

soulsaver said:

Think you are misreading... the blue line is not Fidelity.

The blue line is to show how smaller companies have outperformed the main index. Go to the five year figures at the bottom to see how Fidelity has outperformed HSBC.

tebbins

You are looking at the IA Japan Smaller Companies sector. This is, I think, an equal-weighted average of UK-based OEICs.unit trusts that are available to retail investors. Cap-weighted, these funds probably hold a very small proportion of Japan small cap and so are not as representative of Japan small cap as an index, such as MSCI Japan Small Cap. You can see how the sector and index diverge in the chart below. There could also be slight differences in reporting times so this would probably be more reliable of a weekend.

masonic

I think you'll find you will get different answers over different historical time periods if comparing Japanese small caps and large caps. I don't think there is a clear case that Japanese small caps consistently outperform large caps, but if you want exposure to them, then a strong case can be made for getting that exposure through an active fund. There are 7 active funds in the sector and they all outperformed the index over 5 years, and all 6 with sufficient data outperformed the index over 10 years; there are 3 investment trusts in the sector with a sufficient track record and again these all outperformed over 5 and 10 years.

JohnWinder

If you believed wider diversification was a better bet, then it's HSBC for the better index; but consider how small the difference in returns will be, because one holds 10% more of smaller cap than the other, in a fund which will be a small percentage of all your investments.

If you believed the Fama French story that small companies offer better returns (maybe more risk, but not always) then you still might go for HSBC. But small stock performance compared to large stocks goes through several year cycles of out- and under-performance I think. I have no idea where we are in that cycle, but again it's small beer.

Then you might compare the 'costs'. The obvious one is the published management fee(s). I'd guess the difference is small. Then you'd look at the extra cost you bear with each fund's tracking error from the index; that comes from trading costs in the fund, buy/sell spreads, how well the fund is managed (yes, folks, index funds are managed too). That information hasn't jumped out at me; it's every bit as relevant as the returns over the last x years because it's a cost - maybe that's why it's hard to find. The FCA has already noted that competition on price is weak in UK funds.

I don't know how you weight those elements to aid a choice, but it looks a bit like tweedle dum and tweedle dee. Does it go in any way to explain the original conundrum?

aroominyork

tebbins said:

You are looking at the IA Japan Smaller Companies sector. This is, I think, an equal-weighted average of UK-based OEICs.unit trusts that are available to retail investors. Cap-weighted, these funds probably hold a very small proportion of Japan small cap and so are not as representative of Japan small cap as an index, such as MSCI Japan Small Cap.

Yes, now that you mention it I remember bowlhead explaining the same a few years ago. MSCI/FTSE represents the part of the index those orgs/products track; IA is about the funds in the sector.

masonic said:

I think you'll find you will get different answers over different historical time periods if comparing Japanese small caps and large caps. I don't think there is a clear case that Japanese small caps consistently outperform large caps, but if you want exposure to them, then a strong case can be made for getting that exposure through an active fund. There are 7 active funds in the sector and they all outperformed the index over 5 years, and all 6 with sufficient data outperformed the index over 10 years; there are 3 investment trusts in the sector with a sufficient track record and again these all outperformed over 5 and 10 years.

The small cap funds might well have outperformed the sector, but the reason for selling LT and going passive is because I find Japan an especially unpredictable region, so it makes sense to keep it simple and go with Fidelity. There seems to be more small cap downside risk in Japan than in the UK or Europe.

JohnWinder said:

Then you might compare the 'costs'. The obvious one is the published management fee(s). I'd guess the difference is small. Then you'd look at the extra cost you bear with each fund's tracking error from the index; that comes from trading costs in the fund, buy/sell spreads, how well the fund is managed (yes, folks, index funds are managed too). That information hasn't jumped out at me; it's every bit as relevant as the returns over the last x years because it's a cost - maybe that's why it's hard to find. The FCA has already noted that competition on price is weak in UK funds.

And that's the clincher!

Thanks All - decision made.