Index Investing or Stock Picking? In Japan, It's the Same Thing

  • Mothers index falls hostage to one drugmaker as Sosei soars
  • Weighting distorts gauge's ability to show investor sentiment

Mothers is high on drugs.

Japan’s startup share gauge is surging mostly because of one pharmaceutical company: Sosei Group Corp. The maker of medicines for cancer and lung disease, with little more than 100 employees, has risen fivefold in the past year and now accounts for 15 percent of the Tokyo Stock Exchange Mothers Index. It’s sent the measure to a 13 percent gain in 2016, almost double what it would’ve been if Sosei weren’t around.

“The Mothers index is basically the Sosei index,” said Yoshinori Ogawa, a market strategist at Okasan Securities Co. in Tokyo. “If you take away Sosei, there isn’t much left.”

Sosei has become so big it’s distorting the equity measure and its usefulness as a yardstick of how that universe is performing and what individual investors -- by far its biggest traders -- are thinking. It’s also raising the likelihood the company will move to the bourse’s main board, potentially curtailing the good times for the smaller gauge.

Sosei’s shares have surged 56 percent this year alone, accounting for almost half the advance on the Mothers index. While the gauge has risen 13 percent in 2016, remove Sosei and the gain would be 6.8 percent. The broader Topix index has fallen 17 percent. Sosei dropped 1.4 percent on Tuesday at 9:25 a.m. local time, while Mothers slipped 1.7 percent and the Topix lost 1.4 percent.

Hot Stock

The 25-year-old drugmaker has become one of the hottest stocks in Tokyo, with more more money changing hands in its shares on Monday than some of the country’s oldest blue-chips, such as Sony Corp., Japan’s biggest consumer electronics maker, and Nomura Holdings Inc., the No. 1 brokerage.

Sosei has been on a tear after acquiring U.K. biotechnology company Heptares Therapeutics Ltd. for as much as $400 million in February 2015. The Tokyo-based drugmaker has partnerships and licensing agreements with companies including AstraZeneca Plc and Novartis AG to develop treatments for conditions from cancer to chronic obstructive pulmonary disease, and in November, Pfizer Inc. agreed to buy a 3 percent stake in the firm.

“They’re savvy when it comes to expanding their business,” said Kiyokazu Yamazaki, an analyst at Ichiyoshi Research who covers Sosei. “They don’t necessarily just rely on their own technology, and go out and acquire others if they’re good.”

Major League

It may be only a matter of time before Sosei moves to the major league. The company plans to apply to enter the first section of the Tokyo Stock Exchange before the end of March 2017, it said last year. The minimum requirement for firms to make the move include having at least 2,200 shareholders, 2 billion yen or more in tradable shares, and a billion yen in net assets.

Shifting to the bourse’s main board would make institutional investors more likely to hold the stock and could spur a buying spree in its shares ahead of the move. For Hayato Nagayoshi, chief quantitative analyst at Mizuho Securities Co., it’ll boost Mothers further as the gauge will benefit from Sosei’s rally.

“The share price will rise while it’s still on the Mothers,” said Nagayoshi. “For Mothers, it’s a happy story.”

Mothers, an acronym for “market of the high-growth and emerging stocks,” is a capitalization-weighted measure of 212 stocks worth a total 1.53 trillion yen ($13.8 billion). The top three companies -- Sosei, Cyberdyne Inc. and Mixi Inc. -- account for about 36 percent of the measure, and there’s no limit to how large any one can become.

Index Domination

It’s not unusual for startup indexes to be dominated by one high-flying stock. At the peak of Mixi’s share price in 2014, it was the biggest stock on Mothers, accounting for 17 percent of the measure. It’s natural that a high-growth stock would outgrow such a home and then move on, Okasan’s Ogawa said.

“The Mothers is distorted by a few stocks,” said Seiichiro Iwamoto, a senior fund manager at Mizuho Asset Management Co. in Tokyo. “It’s hard to explain the whole movement of the index as it’s usually down to some select stocks. But it’s a measure for supporting individual companies -- not for tracking the index.”

Futures for Mothers start trading on July 19 in Osaka, according to Japan Exchange Group Inc. The contracts are to let investors hedge positions in the gauge, the exchange said. Given the predominance of companies such as Sosei in the index, it’s questionable how useful such futures will be as a hedging tool, SMBC Nikko Securities Inc. analysts led by Keiichi Ito wrote in a report on March 17.

Increased Expectations

The problem with market cap-weighted gauges like Mothers is that once a company gets bigger, expectations for the stock also increase, making companies even more likely to overrun the measures, Mizuho’s Nagayoshi said. The JPX-Nikkei Index 400, a newer gauge designed to showcase Japan’s most profitable companies, limits the weighting each company can take to 1.5 percent.

“We need an index that is similar but with a cap on the market-value weighting, so we can manage excess expectations,” Nagayoshi said. “Good investment involves performance with little fluctuations. That’s what we expect from an index. That’s unlikely to happen with Mothers.”

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