Japan Exchange and Nikkei to Start New Index Focusing on ROE

Japan Exchange and Nikkei to Start New Index Focusing on ROE

Japan Exchange Group Inc. (8697), operator of the world’s second-biggest equity market, will create an index with Nikkei Inc. that selects members based on return on equity, in a bid to highlight the nation’s best stocks. The bourse operator and Nikkei, which also runs the Nikkei 225 Stock Average, will compile the measure from Jan. 6, according to a statement on Japan Exchange’s website. The gauge will have 400 shares, with 386 Tokyo Stock Exchange first section companies, one from the second section, two from the TSE Mothers market and 11 from Jasdaq. Stocks will include Japan Tobacco Inc. (2914) and Toyota Motor Corp. (7203) as well as Rakuten Inc. (4755) and GungHo Online Entertainment Inc., the bourse said. Eligibility for the JPX-Nikkei Index 400 is based on quantitative factors such as return on equity, operating profit and market value, as well as qualitative aspects such as having at least two independent outside directors and providing earnings disclosure in English, the statement said. “The new index will be composed of companies with high appeal for investors,” according to the statement. “The new index will promote the appeal of Japanese corporations domestically and abroad, while encouraging continued improvement of corporate value.”To contact the reporter on this story: Anna Kitanaka in Tokyo at akitanaka@bloomberg.net

November 7, 2013 10:01 am

New Japanese index targets return on equity

By Ben McLannahan in Tokyo

Farewell Panasonic, Mazda Motor and Tokyo Electric Power.

All are stalwarts of the Nikkei 225 stock average and the Topix, both decades-old benchmarks for investors in the world’s second-biggest equity market.

But none will be included in a rival index to be launched in January, designed to steer more capital towards 400 of the most capital-efficient companies in Japan.

Central to the calculation of the JPX-Nikkei 400 is a three-year record of return on equity employed (ROE), along with various qualitative measures of investor-friendliness, such as independent directors and reports in English.

Slightly more than one-quarter of Nikkei 225 constituents have not made the cut.

“We want to raise awareness of capital efficiency and investor-focused management,” says Atsushi Saito, chief executive of JPX, which runs the Tokyo and Osaka exchanges.

For years, many managers in Japan have paid scant regard to the simple metric of ROE, which is used the world over to gauge how executives are using investors’ equity capital.

After the global financial crisis, amid sluggish markets and general indifference towards Japanese stocks by overseas investors, the disregard seemed to worsen.

Forecast ROEs for Topix 500 companies over the next 12 months average just over 9 per cent, according to Bloomberg, compared with 22 per cent among the S&P 500 and 17 per cent on the Stoxx Europe 600.

A survey published in March by the Life Insurance Association of Japan found that just 37 per cent of companies offered ROE targets, below the 50 per cent share of 2008. A strikingly high share of companies – 15 per cent – said they did not even know their cost of capital.

That could be changing, analysts say. Rising overseas ownership of Japanese stocks in the wake of “Abenomics” has led to more dialogue on ways to improve returns.

But more important is a big domestic push. One element of Prime Minister Shinzo Abe’s plan to revive the Japanese economy is by consolidating its fragmented industrial base, creating more global giants to vie with the likes of GE and Samsung Electronics.

One way of turning up the heat on under-performing companies is to raise the topic of ROE.

“We cannot force any company to merge,” says Yasuhisa Shiozaki, a senior member of Mr Abe’s Liberal Democrat party. “But what we can do is to make a situation where managers have to think about becoming more competitive.”

This month a panel advising the Government Pension Investment Fund – the world’s largest institutional investor, with Y121tn ($1.2tn) in assets – will recommend that the GPIF use the JPX-Nikkei rather than the Topix to assess returns as it makes a push into domestic equities, according to Takatoshi Ito, the panel’s chairman.

The government is also aiming to produce a version of the UK Stewardship Code by the year-end – a move that may encourage institutions in Japan to pressure underperforming managers.

Private-sector groups are piling in. Takeyuki Ishida, head of the Tokyo office of Institutional Shareholder Services, the proxy-voting group, says that he is planning to introduce capital-efficiency metrics into new standards to evaluate directors’ performance – a first in Japan.

Ultimately ROEs are low because people don’t really care

– Kathy Matsui, chief Japan strategist, Goldman Sachs

Some progress is already visible, as companies use excess cash to trim their equity bases. Buybacks of stock this year should top Y2tn, the most since 2008, according to Bank of America Merrill Lynch.

Some companies, such as Fujikura, a manufacturer of wires and cables, which said last week it would spend Y5bn buying back 3 per cent of its shares, are doing so without positive free cash flow.

“We have too many shares outstanding,” says Kazuhito Iijima, finance manager at Fujikura, a Nikkei 225 member which missed out on the JPX-Nikkei. “We want to move towards more debt financing.”

There is, of course, a long way to go. Japanese executives are still seen by US and European investors as “defensive in terms of leverage and margin expansion”, says Naoki Kamiyama, chief strategist at BofA in Tokyo.

But the fact that this ROE push is a primarily domestic effort means that the chances of success are higher, according to analysts. In the past, periodic waves of agitation from abroad – as seen recently at Sony and Japan Tobacco – have not done much to raise broader standards.

“Ultimately ROEs are low because people don’t really care,” says Kathy Matsui, chief Japan strategist at Goldman Sachs.

“Now that there are incentives to show that you do care, we’re getting to the root of the matter.”