New stock index makes waves in Japan
Two years after being plucked from the ranks of exchange product developers to design the JPX-Nikkei Index 400, Daisuke Tanaka finds himself at the centre of a corporate revolution.
Bespectacled and lean at 40, the lifelong employee of Japan Exchange Group is executing a plan backed by the government to shame corporate executives into boosting profits rather than hoarding cash.
Tanaka’s index, which aims to stoke the economy, is changing company behaviour and winning fans such as Goldman Sachs even as detractors deride its makeup and say it will cause investors to buy when valuations peak.
“I feel glad we’ve made this measure,” said Tanaka, who only started studying equity gauges four years ago. “I’ve no regrets about how we set it up.”
Tanaka is at the forefront of an experiment in corporate engineering with an index, considered by some to be a smart beta gauge that ranks companies on profit measures such as return on equity and market value. The gauge started in January and drew attention when Sony Corp was kicked out this month.
Specialised indices are gaining global traction with investors seeking to cut asset management costs. Smart beta funds accounted for about 18 per cent of United States exchange-traded assets at the end of last year, including exchange-traded notes, and grabbed 31 per cent of exchange-traded fund (ETF) net deposits in the year.
Almost US$2 billion was tracking the gauge by August 7 in four ETFs and 19 investment trusts, Japan Exchange president Atsushi Saito said this month. The US$1.2 trillion Government Pension Investment Fund had about US$1.5 billion following the measure through three passive funds, it said.
“When we built it, we didn’t know whether the funds would come,” Tanaka said. “There was a possibility nobody would.”
Tanaka got the call to design the JPX-Nikkei 400 after dabbling with lesser-known measures, including a leveraged index whose value rose as the Topix fell.
Tanaka said he gave himself 80 points out of 100 for his creation.
Others would assign a lower grade. The index is flawed, according to Nicholas Smith, a strategist at stockbroker CLSA in Tokyo, because size outweighs return on equity. Companies with low shareholder returns could sneak in if they ranked high on other criteria, he said, citing Sony and Nomura Holdings.
Sony’s three-year average return on equity was negative 9.1 per cent when the gauge was first compiled. The stock was dumped in the first reshuffle as dwindling operating profit and market value pushed it out of the top 400.
Nomura, Japan’s largest brokerage, remains in even with a three-year average return on equity of 4.8 per cent, compared with a current return on equity of 8.9 per cent for the index.
The JPX-Nikkei measure has another weak spot: it will pick stocks with high return on equity at the top of their cycle, when investors should be selling them, according to Smith. The underlying premise that indices could benefit investors by tweaking their criteria was wrong, he said. “Smart-beta indexing doesn’t work,” he said. “It outperforms in some markets and underperforms in others.”
There are signs that companies are taking the measure seriously. Kawasaki Kisen Kaisha, Japan’s third-largest shipper, adopted a return on equity target for the first time because investors were placing more weight on it, and was seeking returns of 10 per cent in five years, the Nikkei newspaper reported, citing president Jiro Asakura.
Amada, one of 74 firms from the Nikkei-225 left off the JPX-Nikkei 400 when the gauge started, pledged in May to pay out about half its profit in dividends and spend the rest on stock buy-backs to get cash off the balance sheet and boost return on equity.
Minebea, a bearings maker that got on in the measure’s first reshuffle, said this month that it was targeting record return on equity of 20 per cent in the next three financial years.
“This index is about making things better for all Japanese companies,” Tanaka said. “We want those that don’t make it to try to get on. We’ve no intention of writing the rejects off.”