Morningstar: We’re Not Sure Yet About JPX-400 Index

The JPX-Nikkei 400 Index is performing well and attracting flows from ETF investors, proving a valuable resource to access Japan since the index's launch last year, however a passive analyst from Morningstar has said it is too soon to draw firm conclusions about whether this index is fit for the long term.

The JPX-Nikkei 400 Index focuses on companies that will provide shareholder value, and has jumped over 18 percent this year in local currency terms. According to a research note from Lyxor, flows into European-listed smart beta flows slowed down in Q2 compared to Q1, but investors still favoured this Japanese Index. There are now six providers in Europe that have launched funds off the back of the index – Source, Amundi, Lyxor, iShares, db X-trackers, Nomura and ETF Securities.

Morningstar passive research analyst Dimitar Boyadzhiev wrote on 31 July that investing in the JPX Nikkei 400 index allows investors to access well-run companies which prioritise the interests of shareholders. The index screens for qualitative and quantitative factors, rather than market cap, and focuses on a company’s three-year average return on equity and operating profits, to weed out any short-term tactical practices.

Boyadzhiev noted that the JPX has outperformed both the Nikkei 225 and MSCI Japan in local currency terms since launch by 2.2 percent and 2.9 percent respectively, but said the period is not long enough to draw firm conclusions about the index’s potential advantages.

“For example, we do not know how the index will compare in times of elevated volatility, such as those experienced during the Fukushima disaster. Additionally, investors might be missing opportunities by focusing entirely on the ‘quality’ factor and completely ignoring others, which could potentially lead to underperformance,” he said.

Sony was excluded from the index in August 2014 but has since outperformed by more than 60 percent, whereas Panasonic, which was included, has underperformed.

One of the main reasons the Japanese stock market has done so well is due to Prime Minister Shinzo Abe depressing the yen currency. But Boyadzhiev arned that the currency-hedged ETF versions tracking the index display 30 percent to 50 percent higher volatility at three, five and 10 years, and whether investors pick currency hedging depends on their attitude to risk and how long they will hold it.

Michael Stanes, investment director at Heartwood Investment Management, is overweight Japanese equity exporters and did hold a 50/50 currency hedged position, but said yesterday that he believes the trend of yen weakness has run its course in the near term

“Given our reduced expectations for further BoJ stimulus coupled with our view that the yen offers defensive characteristics in the event of a pick-up in general market volatility, we have decided to remove that hedge,” he said.