Japan Quants Baffled by Shame Index Reshuffle as Tepco Sinks

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It turns out numbers aren’t the only things that matter for companies trying to gain entry into the index of Japan’s best companies.

Tokyo Electric Power Co. missed out on a place in the government-backed JPX-Nikkei Index 400 during a reshuffle of the gauge’s members last week, defying forecasts from at least four brokerages that the utility would gain entry because it meets the index’s quantitative criteria. Tepco, as the company is known, tumbled 6.2 percent to 830 yen at the close of trading in Tokyo on Monday, the biggest drop this year.

The operator of the crippled Fukushima Dai-Ichi nuclear power plant became eligible for the index after a surge in its earnings and shares, according to brokerages including Nomura Holdings Inc. and Daiwa Securities Group Inc. While the exclusion of Tepco is understandable “on an emotional level,” it calls into question the transparency of the selection criteria for an index designed to wring better shareholder returns from Japanese companies, said SMBC Nikko Securities Inc.

The reasons for excluding Tepco are “dubious,” Keiichi Ito, chief quants analyst at SMBC Nikko in Tokyo, wrote in a note on Aug. 7. Ito called on the index compilers to “expand upon the index rules and clarify the background to these decisions in order to avoid doubts over the transparency of the process of index compilation.”

Shame, Reward

The JPX-Nikkei 400 is the brainchild of Prime Minister Shinzo Abe and the nation’s biggest bourse. It has the aim of shaming executives of excluded companies into boosting profit and shareholder returns, while rewarding those that make it with investment from the world’s biggest pension fund.

Tepco’s quantitative score is so high that it would have to be removed from the bourse’s initial screening of companies to be passed over, Ito said. The utility also doesn’t fall foul of any criteria for removal from the top 1,000 candidate stocks.

Tepco jumped to 280th place from 973rd last year under the selection criteria, an analysis by Mizuho showed last month.

The utility’s exclusion is “great news” for the JPX-Nikkei 400 index and shows the selection process has a qualitative element, said Amir Anvarzadeh, a manager of Japanese equity sales at BGC Partners Inc. in Singapore.

The company has faced radiation leaks at the Fukushima site, questions over the hiring and treatment of workers there, and has been accused of having a lax safety culture that allowed “man-made” failures to occur before and after the 2011 earthquake and tsunami that crippled the power station.

Toshiba Drops

Index constituents are picked based on three-year average return on equity, which measures how efficiently capital is used, and cumulative operating profit, each accounting for 40 percent of the selection criteria. Market value makes up the remaining 20 percent. About 10 firms can also be replaced based on corporate-governance standards.

Japanese brokerages including Nomura, Daiwa Securities, Mizuho Financial Group Inc. and SMBC Nikko had forecast Tepco would be added after its market value jumped, return-on-equity surged and operating profit turned positive.

Toshiba Corp., which was kicked off the stock index after a $1.2 billion accounting scandal, slid 1.4 percent Monday, while Lixil Group Corp., also removed following accounting irregularities at a subsidiary, tumbled 5.1 percent. Daio Paper Corp., which was added, surged 12 percent.

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