BOJ Adopts Shame Gauge as Japan Targets Higher Returns

Buried amid the surprise stimulus by the Bank of Japan last week was a footnote: the central bank will start using an equity gauge designed to shame the nation’s companies into becoming more profitable.

The BOJ can buy exchange-traded funds tracking the JPX-Nikkei Index 400, it said Oct. 31, when it tripled annual purchases of ETFs to about 3 trillion yen ($26 billion). The nation’s $1.1 trillion Government Pension Investment Fund is already investing in the state-backed equity measure created to make Japanese companies use cash better.

For Mitsubishi UFJ Asset Management Co. and SMBC Nikko Securities Inc., the BOJ’s move shows Japan will put its money where its mouth is in seeking to improve return on equity at the nation’s companies. Other efforts include a government-endorsed ROE target of 8 percent and a stewardship code that enlists investors to press management for higher returns.

“The government is continuing to put pressure on companies and investors,” Takashi Miyazaki, general manager of strategic research and investment at Mitsubishi UFJ Asset, said by phone from Tokyo on Nov. 4. “ROE on the Nikkei 225 Stock Average currently averages about 10 percent. If that rose to 12 percent, the Nikkei 225 would probably climb to 20,000.”

The JPX-Nikkei 400 sank 1.2 percent today in Tokyo, while the Nikkei 225 dropped 0.9 percent. The so-called shame gauge is up 5.2 percent in 2014, compared with a 3.1 percent gain for the older index.

Half Average

Return on equity, a measure of the profit companies make from shareholders’ funds, stood at 8.3 percent on the Nikkei 225 at the end of last quarter and 9.4 percent on the JPX-Nikkei 400, according to data compiled by Bloomberg. That compares with 15.3 percent for the Standard & Poor’s 500 Index in the U.S.

ROE at Japanese companies was half the global average for much of the past decade, and among the lowest of 24 developed markets tracked by Bloomberg. The Topix index’s average for the 10 years through 2013 was 6 percent, beating only Greece’s ASE Index, data compiled by Bloomberg show. Companies in the S&P 500 delivered 13.6 percent, while the Stoxx Europe 600 Index returned 13 percent and the MSCI World Index’s average ROE was 12.6 percent.

“The government is moving toward increasing ROE as part of its growth strategy,” said Hiroichi Nishi, an equities manager at SMBC Nikko Securities in Tokyo. “Now, not only GPIF but also the BOJ is using the index. That’s probably going to have a big knock-on effect on other funds.”

Gaining Traction

GPIF said in April that it had adopted the JPX-Nikkei 400 as a benchmark. The world’s biggest pension fund had about 150 billion yen tracking the index in three passive funds as of the end of March. Japan Exchange Group Inc., which created the measure along with Nikkei Inc., said last month that 295 billion yen was following the gauge as of Oct. 30.

JPX-Nikkei 400 futures are scheduled to start trading from Nov. 25 amid demand from investors to use them for hedging purposes, according to Japan Exchange.

“It’s easy to influence the Topix and Nikkei 225 using futures trading,” said Masayuki Doshida, a senior market analyst at Rakuten Economic Research Institute. “By buying ETFs tracking these indexes, the BOJ was able to support the market in times of futures selling. With JPX-Nikkei 400 futures set to start trading, the BOJ didn’t have a mechanism to protect the market if they were sold off.”

Dumb Beta

Nicholas Smith, a strategist at CLSA Ltd. in Tokyo who has called the JPX-Nikkei 400 a “dumb beta” that encourages investors to buy at the top of the cycle, was more positive about the measure yesterday. He pointed to Amada Co., a machinery company that pledged to pay out all its profit to shareholders as a way to be chosen for the gauge.

“Government policy is focusing on emphasizing return on equity,” Smith said by e-mail. “The simple fact is that, as the Amada story highlighted, companies are buying back shares and rectifying their behavior to try get in the index. And that can only be a good thing.”

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