The Bank of Japan goes wild for ETFS

Stimulus ▶ Japan’s central bank wants to buy an ETF that doesn’t yet exist ▶ “It’s the same as if the BOJ were buying individual stocks”

Exchange-traded funds, the indexbased portfolios that can be traded like stocks, grew to almost $3 trillion in global assets by the end of 2015. Individuals and big institutions alike use them to cut investment costs and diversify quickly. In Japan they assume another role: as a tool for the Bank of Japan to manage the nation’s economy.

The central bank is already

waist-deep in the market, and it’s about to wade even deeper. The BOJ holds half the ETF shares in the country. In December it announced it would invest $2.6 billion more, taking its annual purchases to $28 billion. This money would go into ETFS that track Japanese companies “proactively making investment in physical and human capital,” the bank said.

The hitch is that no such funds yet exist. “I think the message from the BOJ is for us to go out and make them,” says Koei Imai, who oversees ETF investments at Nikko Asset Management in Tokyo. “Using capital spending as a factor in deciding what goes in an ETF is quite unusual.”

Other central banks venture into markets to buy bonds—the U.S. Federal Reserve and the Bank of England have both done so. Buying stocks via ETFS is a novelty. The BOJ started doing it in 2010 as a catalyst to promote more risktaking in the economy.

ETFS seemed a suitable way for the BOJ to purchase shares without choosing one company over another. The bank invested mainly in funds that track major indexes such as the Topix and the Nikkei 225.

Recently, however, policymakers have begun using stock purchases to influence corporate behavior. A government-backed stock index begun in 2014 showcases companies the Tokyo bourse sees as the nation’s best. Companies are selected by return on equity and profitability, two areas where Japan Inc. has traditionally fallen short. Japan’s government pension fund, the world’s largest manager of retirement savings, and the BOJ are among the state investors that have directed large sums to this index.

Investing in a capital expenditure ETF would make the BOJ’S nudge a little harder. Corporate cash-hoarding and stagnant wages, a response to 15 years of falling prices, are seen as thwarting the bank’s attempts to spur growth. Companies that spend cash to put their profits to work will be rewarded by the BOJ purchasing their shares via the ETF.

A side effect of the ETF push could be to bring change in Japan’s financial industry, says Jesper Koll, head of the new Tokyo office of Wisdomtree Investments, an ETF manager. Most ETFS in Japan track wellknown indexes. So- called smart beta strategies—baskets of stocks selected for factors such as dividends or profitability—haven’t taken off as they have in the U.S. The BOJ’S move is a wake-up call, says Koll.

Stimulus from the BOJ is a key element of Prime Minister Shinzo Abe’s policy program, dubbed Abenomics. Although the central bank has stemmed deflation, it is nowhere near its target of 2 percent inflation. (Risrising prices would be a sign Japan is returning to healthy growth.) With oil prices roiling the market, many investors expect more BOJ asset purchases ahead.

But some worry that the bank’s role in ETFS takes things too far, especially if the funds favor certain companies. Says Yoshihiro Ito, chief strategist of Okasan Online Securities in Tokyo: “It’s the same as if the BOJ were buying individual stocks rather than pushing up the overall market.” The bottom line Japan needs corporations to stop hoarding cash. The BOJ thinks an ETF that favors growth-oriented companies could help.