Japan Tries to Alter the Market's DNA
The government of Japanese Prime Minister Shinzō Abe has come up with a tool to shame chief executive officers into boosting returns and encourage big pension funds to put more money into the Tokyo stock market. It’s called the JPX-Nikkei Index 400, a stock gauge that showcases companies that make good use of investors’ cash.
Japan was home to one of the world’s best-performing equity markets last year, in large part because foreign investors are enthralled by Abenomics—the prime minister’s efforts to reflate the country’s long-stagnant economy. Yet Japanese companies are still laggards compared with their U.S. and European counterparts when it comes to focusing on shareholder returns, according to Peter Elston, head of Asia-Pacific strategy at Aberdeen Asset Management.
That’s because they give as much attention to the needs of employees and business partners as to investors, he says. Japanese CEOs also tend to be more risk-averse and hold a lot of cash. The results can be seen in return on equity (ROE), a measure of how efficiently a company uses the money shareholders invest in it. Japanese companies in the Topix index—a broader measure than the Nikkei 225—averaged a 6 percent return on equity over the 10 years through 2013, compared with 12.6 percent for the companies in the MSCI World Index, data compiled by Bloomberg show.
For the JPX-Nikkei 400, launched in January, companies were selected based on ROE (they averaged 11 percent over the past three years), cumulative operating profit, and market value. Some prominent names didn’t make the cut, including Panasonic, which is restructuring to improve profits after record losses; Olympus, an endoscope and camera maker rocked by accounting fraud in 2011; and Tokyo Electric Power, the utility at the center of the 2011 Fukushima nuclear accident. “Being chosen for the JPX-Nikkei 400 will be like getting a certificate from the government,” says Kiyoshi Yamanaka, executive officer of T&D Asset Management. “In the long term, ROE should improve as companies who were not chosen for the index, and who care about how investors see them, try to get onto the measure.”
Abe has been trying to shake Japan out of its economic torpor. A policy paper released by his Liberal Democratic Party in November 2012 proposed using a new stock index to influence the priorities of companies and public investment funds. Atsushi Saito, the CEO of Japan Exchange Group, says the Tokyo exchange owner and Nikkei, its partner in publishing the index, came up with the idea themselves. That’s not the whole story, according to Yasuhisa Shiozaki, the LDP’s deputy policy chief. “It was us,” he says. “They said 500 companies at first,” while the LDP suggested 300, “so they took the middle ground and chose 400.” Some analysts are put off by the government meddling in the stock market. “I’ve never heard of anything like this happening anywhere else,” says Ayako Sera, a market strategist at Sumitomo Mitsui Trust Bank. “It sounds like something that would happen in China, where government control runs deep. It’s very shady.”
Along with prodding companies to improve performance, another goal of the index is to get big investors such as the Government Pension Investment Fund to put more cash into the stock market, according to Jonathan Allum, a strategist at SMBC Nikko Capital Markets. The fund has 124 trillion yen ($1.2 trillion) in assets, mostly invested in sovereign bonds. Many pensions and other institutional investors do some or all of their stock investing via funds that follow broad indexes. Their buying can increase the value of the companies in the index and allow them to raise more capital for expansion.
The government pension fund’s president, Takahiro Mitani, said in December that the fund is “still considering” whether to adopt the JPX-Nikkei 400 as its benchmark. His decision is likely to influence other investors. “I’m still watching, as the pension funds haven’t decided to use the JPX-Nikkei 400 yet,” says Tomomi Yamashita, a fund manager at Shinkin Asset Management. “If GPIF starts using it as a benchmark, then other pension funds will follow.”
Getting large investors on board will be key, says Naoki Kamiyama, chief equity strategist in Tokyo at Bank of America Merrill Lynch. “If everyone starts investing in this index, they can start pointing fingers at the companies without high ROE,” he says. “I think it’s correct for the government to use policy to try to change people’s behavior.” Sumitomo Mitsui Trust’s Sera says the administration has better tools, “such as lowering corporate tax rates or easing regulations—something a normal government would do.”
Whatever its merits as a growth tool, the index may not be a boon for investors, according to SMBC’s Allum. “Buying high-ROE stocks isn’t necessarily a good strategy in itself,” he says. “Investment is about quality vs. value. Being included in the index is a badge of honor for the company. But for the investor, you may end up buying cyclical stocks at the top of the cycle.”