If Japan's Stock Market Rally Returns, These 3 ETFs Could Benefit

Key Points

• After gaining ground through early 2026, the Nikkei 225 lost momentum in the second half of the year, with AI-sector volatility and Bank of Japan rate hikes adding pressure.
• Investors seeking renewed upside in Japanese equities can choose among three ETFs that differ by currency hedging, company size focus, and dividend income potential.
• DXJ's yen-hedged strategy has delivered the strongest returns at nearly 23% YTD, while EWJ offers large- and mid-cap diversification and DFJ provides small-cap exposure with a 2.51% yield.

The Nikkei 225's momentum throughout 2023 and 2024 accelerated in 2025 and early 2026, but in the second half of the year the rally stalled and began to reverse course. While the index has still climbed by about 21% year to date (YTD) overall—easily beating the S&P 500 over the same period—the reliance of Japanese equities on the global AI investment cycle means that a continuation of the AI sell-off may hit the Nikkei particularly hard. The Bank of Japan's recent hikes to its historically low interest rates may also be putting pressure on equities.

At the same time, if Japanese earnings improve, corporate governance reform yields better efficiency, domestic consumption increases, or the energy and AI industries stabilize—or particularly if any combination of those developments takes place—Japanese equities could be in a position to quickly bounce back. Exchange-traded funds (ETFs) like the WisdomTree Japan Hedged Equity Fund NYSEARCA: DXJ, the iShares MSCI Japan ETF NYSEARCA: EWJ, and the WisdomTree Japan SmallCap Dividend Fund NYSEARCA: DFJ all offer unique ways to benefit.

DXJ: Winning Because of the Yen's Weakness

A medium-sized ETF but the cheapest on this list by a small margin, DXJ combines breadth of exposure to the Japanese equities space with a hedge on exposure to the yen. This may be a particularly attractive approach for international investors at this point because the yen has been weak, increasing the cost of imported energy and materials even beyond what rising global prices would already dictate. A weaker yen also pressures businesses, particularly those unable to pass along costs to consumers.

DXJ positions itself as a pure play on Japanese stocks, which is compelling for investors expecting the yen to continue to remain depressed or to become weaker still relative to the dollar. The fund has a broad basket of close to 500 equities across market capitalizations and sectors, and its top positions remain relatively well distributed to avoid over-concentration in any particular name.

In terms of performance, DXJ has not fallen by as much as the broader Nikkei in the last month and has also outperformed the index overall YTD, returning almost 23% in 2026. Investors expecting the yen to strengthen may still want to avoid the fund, though, as it will likely underperform non-hedged alternatives in that situation.

EWJ: Despite Underperformance, a Solid Access Point for Large Japanese Companies

Likely the best-known and among the very largest and most-traded Japan-focused ETFs, EWJ holds some $23 billion in assets and has a 30-year trading history. With an expense ratio just one basis point above DXJ's, EWJ remains competitive in terms of cost as well.

EWJ's portfolio is narrower than DXJ's because of its focus on large- and mid-cap names, but the fund's roughly 175 holdings remain fairly evenly weighted nonetheless. Crucially, despite prioritizing bigger companies, EWJ also has strong diversification across sectors. This may appeal to investors looking to avoid significant overexposure to tech and AI names at a time when the industry is experiencing unusually high volatility.

Despite the advantages of narrow spreads and moderate cost compared to some other funds in the niche country-specific space, EWJ has not performed as well as some of its peers this year. It has fallen by 6% in the last month, a wider margin than DXJ though not as much as the broader Nikkei. It remains up about 14% YTD, but this is short of the Japanese equities space overall. Still, it remains a popular choice for a buy-and-hold approach for investors looking to build up exposure to major Japanese firms.

DFJ: Local Small-Cap Focus With a Strong Dividend

The smallest and most expensive fund on this list, DFJ has an annual fee of 0.58%, about 10 basis points higher than EWJ. Still, the fund's unique approach—targeted investments in small-cap Japanese equities that pay dividends—may justify the trade-offs investors face in terms of cost and liquidity.

Some investors consider small-cap stocks to be a more direct expression of a country's local economy, as they tend to not have the same ties to global markets as large- and mega-cap names with a major international presence. DFJ's portfolio is large, comprising close to 1000 different companies, and it also avoids over-concentration to an extreme degree—no single position occupies more than about half a percent of the portfolio.

The result is that this fund is not dependent on the performance of any single company, making it a broader play on an important but often overlooked space within the broader Japanese market. That small-cap corner has performed fairly well this year, rising by more than 14% YTD. The appeal of the fund is broader still, though, because of its 2.51% dividend yield.