It’s been a big couple of weeks for Japanese stocks after a surprise announcement that the Bank of Japan was again opening the stimulus taps and letting even more money flow into its capital markets. However, there was one small caveat to the capital flow was tucked away at the bottom of the press release.
The Bank of Japan will start using an equity gauge that is ostensibly governance-based. The JPX-Nikkei Index 400, launched last year, has also been referred to as a “shame index” because of its focus on return on equity (ROE) as a key measure of inclusion.
The goal of the index is to put the spotlight on companies sitting on piles of cash while delivering too low returns on equity. It’s a big problem in Japan, says Prime Minister Shinzo Abe, who claims companies like those are the reason Japanese economic growth has been so low.
He’s got a point: ROE at Japanese companies has been depressingly low by global standards, sitting at half the global average for much of the past decade, says Bloomberg.
The Bank of Japan will now start buying exchange-traded funds (ETFs) that track the new shame gauge, following in the footsteps of the world’s largest pension fund, the US$1.1-trillion Government Pension Investment Fund, which has been investing in the index since earlier this year.
So who’s in the index? The Tokyo Stock Exchange says the scoring is based on the following quantitative indicators (among other characteristics):
three-year average ROE: 40%
three-year cumulative operating profit: 40%
market capitalization on the base date for selection: 20%
The companies in aggregate hold a “high appeal for investors” and represent “investor-focused management perspectives.”
And ETFs based on this index will, ostensibly, give investors access to companies with one major mission: to deliver returns to investors in exchange for the money they invest.
In return, companies included in the index can expect to see their share prices rise exponentially.
A win-win, right?
Well, not so fast, say some critics. Some say it encourages investors to buy at the top of the cycle—and it also neglects more qualitative measures, leading some to dub it “dumb beta.” For example, what about companies that choose to reinvestment capital to fund innovation that will enable future growth?
Which brings us back to the question of Japan’s central motivation in investing in companies included in this index: can good governance as it is defined in the index really save the Japanese economy? And, if so, do you think such a measure (and an ETF based on it) would work for companies in Canada?
Your thoughts welcome below…