A short summary
Japan's primary stock index, the TOPIX, is undergoing a major transformation. A multi-year restructuring programme is set to almost halve the number of its constituent companies by 2028, creating a more concentrated and globally competitive benchmark. In addition to improving the index, these reforms may trigger changes in capital allocation relevant for company management and investors in Japanese equities.
For years, the TOPIX was more of a broad census than a selective index. At its peak, it comprised almost 2,200 companies, including a long tail of small, domestically focused firms. This resulted in a fragmented market that lacked appeal to foreign investors. The inefficiency was stark: an estimated 60% of constituents did not even earn their cost of capital. When compared to more streamlined developed market counterparts like the S&P 500 the need for an index of better-governed, more profitable companies became undeniable.
The background to reform
The TOPIX was launched in 1969 as a comprehensive market-cap weighted index whose universe was all domestic common stocks listed on the ‘First Section’ of the Tokyo Stock Exchange.
Historically, the TSE was made up of four categories: First Section, Second Section, Mothers and JASDAQ (Standard and Growth). The First Section was intended to be an exclusive club for high-quality blue chips, with stringent listing and maintenance criteria. However, over time this lapsed and the First Section gradually became home to more than half of all listed companies.
In the first stage of reform, the entire First Section was transferred to the Prime market on a probationary basis. Then, in April 2022, all constituents were consolidated into three new sections:
- Prime market: Comprises companies with high liquidity, strong governance, and a commitment to constructive dialogue with global investors. These firms are expected to lead the global economy.
- Standard market: Companies with a solid business foundation and certain level of market capitalisation and liquidity. These firms play a central role in the Japanese economy.
- Growth market: Designed to house smaller companies with high growth potential, which also carry higher investment risk.
A more competitive landscape
The TOPIX’s evolution into a more carefully curated index, with rigorous, liquidity-focused stock selection criteria based on free-float adjusted market cap and annual traded value ratio is the biggest anticipated change on the horizon.
Free-float adjusted market cap considers only the value of shares readily tradable in the market and excludes shares held by stable shareholders, such as parent companies, cross-shareholdings, and internal executives. The idea is that companies are incentivised to focus on improving shareholder returns. As we have noticed some companies explicitly expressing their intention to remain in or to join the TOPIX, early signs suggest it’s working.
Qualifying stocks from any of the three markets can enter the TOPIX. The more competitive landscape is expected to stoke action from company management, especially among smaller and mid-sized companies seeking a listing. Although many global investors eschew it as a benchmark in favour of the more widely used MSCI Japan, we estimate over ¥100tn (approx. £500bn) of AUM is held in passive TOPIX-linked strategies alone.
It is anticipated these planned reforms could improve the overall return on equity (ROE) of the index by roughly 20% if constituents divest from unprofitable businesses. The first phase of the reforms concluded in January, which involved a multi-stage, gradual reduction in the weighting of companies with a tradable share market capitalisation below ¥10bn. This has already reduced the number of TOPIX constituents from more than 2,100 to around 1,700.
Japan’s collaborative efforts
While concerted, cooperative efforts are taking place between the stock exchange, the regulator, and Japan’s government, the real structural changes happening in Japan’s public markets are not purely due to such top-down initiatives. The economic uptick witnessed in recent years – namely the move from deflation to inflation – coupled with this index reform are together underpinning a surge in corporate activity.
The increased level of M&A activity seen in Tokyo today is drawing more international attention to Japanese equities as an asset class. Over the past 12-18 months, the number of takeover bids and management buyouts (MBOs) have both spiked sharply upwards. In the case of smaller companies in particular, MBOs are becoming more common as private equity (PE) funding gains traction. Business owners are securing PE backing, which allows them to buy the remaining stake in their company and take it off the public market. In some cases, these deals will be looking to improve the company’s operations, readying to relist in future.
A broader alpha opportunity?
At Sumitomo Mitsui DS Asset Management, while we run strategies that span the market-cap spectrum, this reform programme is most relevant to our small- and mid-cap (SMID) equity platform. And our SMID team is viewing these changes as net positive.
The lead manager thinks it will not only improve the overall quality of the index, but anticipates the dispersion between winners and losers will widen such that – as an active manager – a richer opportunity set to discover alpha will prevail.
We see these reforms as a viable pathway to set-up Japanese companies for greatness; positioning them for international expansion, higher levels of sustainable profitability, and bringing the quality of the market in line with global standards.
Invest with us
If you have any account or dealing enquiries, please contact BBH using the following contact details:
Brown Brothers Harriman (Luxembourg) S.C.A.
80, route d’Esch, L-1470 Luxembourg
T: +352 474 066 226
F: +352 474 066 401
E: Lux.BBH.Transfer.Agent@BBH.com
Source: SMDAM
General Disclaimer:This material is issued by Sumitomo Mitsui DS Asset Management (Hong Kong) Limited (“SMDAM(HK)”) for informational purposes only and has not been reviewed by the Securities and Futures Commission of Hong Kong (“SFC”) or any other regulatory authority. Persons who access or receive this material should determine whether it is permissible to access or receive it in the relevant jurisdiction without violating any applicable laws and regulations. The material may contain information related to funds which are authorized by the SFC that are available for public sale in Hong Kong. However, SFC authorization is not a recommendation or endorsement of the fund, nor does it guarantee the commercial merits of the fund or its performance. It does not mean the fund is suitable for all investors, nor is it an endorsement of its suitability for any particular investor or class of investors. The information contained in this material has been obtained from sources that are deemed to be reliable and is made available solely for informational purposes. SMDAM(HK) makes no representations or warranties as to the information and does not guarantee its accuracy, timeliness, completeness or usefulness. You are advised to exercise caution in relation to this material, and if you are in any doubt about the contents of this material, it is recommended that you should seek the advice of an independent professional. The written consent of SMDAM(HK) is required before it can be replicated or distributed to third parties or used for any other purpose, except as required by law or regulatory requirements. SMDAM(HK) and its affiliated entities accept no liability whatsoever for any consequences, whether direct or indirect that may arise from any third party’s use of information contained in this material. This material is not intended to serve as an invitation, offer, solicitation or recommendation for any investment strategy or the purchase or sale of securities, including shares or units of funds. Any views, analyses, perspectives expressed, and references to companies should not be construed as recommendations or endorsements by SMDAM(HK). All comments, opinions, data and forecasts in this material are based on the information available at the time of drafting, and are subject to change without prior notice in response to market and other conditions. The information provided does not constitute investment advice and should not be relied upon as such. This material may contain certain statements that may be deemed to be forward-looking statements. Please note that any such statements are not guarantees of future performance and actual results or developments may differ significantly from those projected. No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. This material does not have any regard to the specific investment objectives, financial situation and the particular needs of any specific person who may access or receive this material. Investment involves risk, including the possible loss of principal amount invested. The past performance information of the market, manager and investments and any forecasts on the economy, stock market, bond market or the economic trends of the markets are not indicative of future performance. Any investment decisions made by investors should not be solely based on this marketing material. Investors should refer to the fund’s Offering Documents, including the Product Key Facts Statement, in order to fully understand the associated risk factors. The value of an investment may go down or up. The final decision in relation to any investment in any stock, companies or markets referred to in this material should be made by you. If investment returns are not denominated in HKD or USD, US/HK dollar-based investors will be exposed to exchange rate fluctuations. The contents of this material are protected by copyright. Without SMDAM(HK)’s prior written consent, copying, reproduction or distribution of its contents in a hard copy and/or through the internet is strictly prohibited. Where the contents of this material have been translated into any language other than English and there is any inconsistency or ambiguity between the English version and the other version, the English version shall prevail. The above policies are subject to review and amendments by us from time to time. IMPORTANT: Please read this disclaimer carefully. By accepting this presentation, you acknowledge that you have read, understood, and agreed to be bound by the terms and conditions set forth herein. |
General Disclaimer:This material is issued and distributed by Sumitomo Mitsui DS Asset Management (Hong Kong) Limited (“SMDAM(HK)”) exclusively intended for “Professional Investors” (as defined in the Securities and Futures Ordinance (Cap. 571) and/or the Securities and Futures (Professional Investors) Rules (Cap.571D) under the laws of Hong Kong) for informational purposes only, and is not intended for distribution to the general public. It is recommended that you seek the advice of a professional financial or legal advisor to assist in due diligence and determine the appropriateness and consequences of being treated as a Professional Investor. This material has not been reviewed by the Securities and Futures Commission of Hong Kong (“SFC”) or any other regulatory authority. The information contained in this material has been obtained from sources that are deemed to be reliable and is made available solely for informational purposes. SMDAM(HK) makes no representations or warranties as to the information and does not guarantee its accuracy, timeliness, completeness or usefulness. You are advised to exercise caution in relation to this material, and if you are in any doubt about the contents of this material, it is recommended that you should seek the advice of an independent professional. This material and the information it contains are strictly confidential, the property of SMDAM(HK), and are intended exclusively for the intended recipients. The written consent of SMDAM(HK) is required before it can be replicated or distributed to third parties or used for any other purpose, except as required by law or regulatory requirements. It is not intended for distribution or use by any individual or entity in any jurisdiction or country where such distribution or use would be in violation of local law or regulation. SMDAM(HK) and its affiliated entities accept no liability whatsoever for any consequences, whether direct or indirect that may arise from any third party’s use of information contained in this material. This material is not intended to serve as an invitation, offer, solicitation or recommendation for any investment strategy or the purchase or sale of securities, including shares or units of funds. Any views, analyses, perspectives expressed, and references to companies should not be construed as recommendations or endorsements by SMDAM(HK). All comments, opinions, data and forecasts in this material are based on the information available at the time of drafting, and are subject to change without prior notice in response to market and other conditions. The information provided does not constitute investment advice and should not be relied upon as such. This material may contain certain statements that may be deemed to be forward-looking statements. Please note that any such statements are not guarantees of future performance and actual results or developments may differ significantly from those projected. No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. This material does not have any regard to the specific investment objectives, financial situation and the particular needs of any specific person who may access or receive this material. Investment involves risk, including the possible loss of principal amount invested. The past performance information of the market, manager and investments and any forecasts on the economy, stock market, bond market or the economic trends of the markets are not indicative of future performance. Any investment decisions made by investors should not be solely based on this marketing material. Investors should refer to the fund’s offering document in order to fully understand the associated risk factors. The value of an investment may go down or up. The final decision in relation to any investment in any stock, companies or markets referred to in this material should be made by you. If investment returns are not denominated in HKD or USD, US/HK dollar-based investors will be exposed to exchange rate fluctuations. The contents of this material are protected by copyright. Without SMDAM(HK)’s prior written consent, copying, reproduction or distribution of its contents in a hard copy and/or through the internet is strictly prohibited. Where the contents of this material have been translated into any language other than English and there is any inconsistency or ambiguity between the English version and the other version, the English version shall prevail. The above policies are subject to review and amendments by us from time to time. |
United Kingdom
Switzerland
Luxembourg
Germany
Finland
Ireland
Netherlands
Rest of EEA
Middle East
Japan 日本
Hong Kong 香港
Singapore 新加坡
USA
Other