The Bank of Japan’s (BoJ) recent decision to adjust its ETF purchase programme has given investors plenty to think about from the impact on asset prices to the longer term future of the country’s monetary easing policies. In this paper, investment director Christophe Braun analyses the fallout from the central bank’s policy tweaks and explains why active investing is an attractive approach for Japanese equities.

Some sections of the investment community have long been lobbying against the BoJ’s purchase of ETFs, claiming the programme has distorted the supply and demand dynamics of the Japanese equity market. Others have questioned whether the central bank should be filling its balance sheet with such a large amount of risk assets. In total, the BoJ has accumulated ¥35.7 trillion worth of ETFs since the programme’s debut in December 2010 and, in the process, turned itself into the largest owner of Japanese equities¹.

The BoJ’s ETF purchase programme was first initiated as part of a coordinated push to stimulate the Japanese economy, reflate growth and pull the country out of deflation. Originally, it had an annual purchase target of ¥450 billion, which eventually ballooned to ¥6 trillion before the central bank’s decision to remove the explicit guidance in late March 2021. In the same announcement, the BoJ also said it will be keeping the annual ¥12 trillion ETF purchase ceiling intact although any future purchases of ETFs would be confined to those that track the Tokyo Stock Price Index (TOPIX). Previously, the ETF purchase programme encompassed ETFs that track the TOPIX, the Nikkei 225 and the JPX-Nikkei Index 400.

There are good reasons for the BoJ’s latest policy adjustments. Fine-tuning the programme allows the BoJ to slow its purchases, setting the groundwork for it to eventually curb its ownership of Japanese stocks and allay investor concerns about the longer-term sustainability of its easing measures. Yet by keeping its annual ¥12 trillion purchase ceiling of ETFs intact, the BoJ has given itself the flexibility to intervene and support the market as and when the situation warrants it.

The fallout

Speculation that the BoJ would modify its ETF purchase programme by removing the annual purchase target had been mounting for months especially given the performances of key Japanese equity indices. The TOPIX, for example, hit an all-time high as recently as the middle of March while the Nikkei 225 is also trading close to a multi-year high².

In the short term, the BoJ’s latest actions are only likely to impact sentiment instead of having a substantial impact on market dynamics. That is because the BoJ has made it clear that it remains committed to monetary easy and removing the annual purchase target does not mean it would be halting its purchases of ETFs.

Over the longer term, however, the inevitable reduction of ETF purchases by the BoJ will undoubtedly have an impact on passive assets but also Japanese equities as a whole. Yet just how much of an impact would depend on the method the BoJ eventually chooses to clear its ETF holdings. The most obvious approach would be to dispose of all the BoJ’s ETF holdings directly into the market, which would certainly have a negative impact on stock prices. Consequently, market assumptions are veering towards a number of off-market measures, including having the Government Pension Investment Fund (GPIF) purchase the BoJ’s holdings; offering the ETFs to the public retail space at a discount to their net asset value; transferring all of the ETFs to a newly established university fund; distributing ETF shares into individual defined contribution retirement accounts; and asking companies to buy shares back from the BoJ³.

 

1. Data as at 28 February 2021. Source: Bank of Japan .

2. Data as at 24 May 2021. Source: Bloomberg .

3. Based on a 17 January 2021 news article outlining potential BoJ ETF exit scenarios.
Source: Nikkei Asia

 

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
• Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.