The index constituents are determined by identifying the best 400 companies in Japan using a number of quantitative and qualitative factors, including three-year return on equity (RoE), cumulative operating profit as well as information disclosure.
One distinguishing factor for constituents within this new index is the three-year average RoE of 11.1%, compared with only 3.9% for those excluded. Potentially more interesting is the need to adopt the International Financial Reporting Standards regulation report and accounts, and the pressure to appoint independent outside directors to the board. Having a strong corporate governance system is important to international investors and is another step in the right direction for Japan plc.
New perceptions
For many years it has been argued that Japanese companies pay more attention to market share than profitability or the desires of shareholders, and this new index will surely change perceptions. The strict criteria align interests of a more traditional buy-and-hold investor with the companies within the index.
In April, the GPIF announced it was going to change the way it benchmarked some of its investment mandates away from TOPIX and toward the JPX-Nikkei 400, which is further proof that things are changing. If corporate management wants the longer-term capital from investors such as the GPIF to buy into the concept, we could be witnessing the start of a renaissance of investing into the Japanese stock market.
The index at present includes a large number of well-known and large names – Toyota, Japan Tobacco, Honda, Canon – alongside lesser-known names such as the internet company Rakuten, owner of play.com, rental housing developer Daito Trust Construction and tyre manufacturer Bridgestone. All these companies have met the eligibility criteria.
Combined with the fact GPIF is likely to up its asset allocation to equities during the next five years, the demand for stock is likely to rise. A Towers Watson survey suggests domestic pension funds owned $2trn in 2012 in Japanese equities, and the GPIF alone is likely to invest between $50bn and $100bn into the Japanese equity market.
If GPIF is directing/redirecting funds to constituent stocks within the JPX-Nikkei 400 index, it makes sense for fund managers of Japanese equities to pay attention to these criteria and incorporate them into their due diligence.
Lock, stock and barrel
The trouble for a fund selector is where to invest. I chose the Cardiff Coupland Japan Income & Growth Fund at launch 12 months ago and have been rewarded handsomely, but believe there is further to go from here.
The portfolio is concentrated with about 35 holdings, though fund manager Richard Aston has delivered excellent results so far in the relatively short life of the fund.
The model portfolio was in place for two years before launch and even though a portfolio of only 35 stocks might be considered high risk, each of the companies is financially sound and has demonstrated favourable attitudes towards its shareholders. The portfolio turnover is consequently incredibly low and it is managed in a conservative manner, with the top 10 holdings accounting for a little over one third of the total assets and the biggest holding roughly 4%.
Aston is mindful of total shareholder return and is content that 17 of the stocks have seen share buybacks in the past 18 months. Also, when looking at the stocks in the fund, he is pleased to see the average five-year dividend growth of more than 10% compared with -1.5% from the TOPIX index.
Japan equity as an asset class is a great diversifier – correlations are not high to other markets, which makes it an interesting component for a broad portfolio. A fund such as CC Japan Income & Growth can provide the potential of capital growth, dividends, growth of dividends and, at less than £80m in size. With a low correlation to the peers and the index compared with the main players in the market, it is certainly worthy of further investigation.
