Opinion | Analysis from Richard Aston on how the BoJ’s massive ETF stockpile can sustain Japan’s domestic investment boom

by | Jun 12, 2024

Following the Nikkei’s record rally, Richard Aston, portfolio manager of the CC Japan Income & Growth Trust and the Chikara Japan Income & Growth Fund, highlights yet more reasons why he’s feeling rather positive about the investment opportunities in the land of the rising sun

The Bank of Japan (BoJ) ’s decision to increase interest rates in March has been heralded as its first step towards policy normalisation after an era of battling deflation.

A lesser reported aspect of the shift, however, has been the central bank’s move to discontinue purchases of Japanese exchanged-traded funds (ETFs).

In our view, this is equally significant. The BoJ has been buying ETFs for some 14 years, and its position is worth some 70 trillion yen (~US$460 billion) – nearly double book value.

Now that purchases of ETFs are off and nationwide inflation is prevalent, calls for the government to purchase this large holding and redistribute it to Japan’s younger generation at a discount are growing.

We believe such an approach could offer Japan’s government another powerful tool in its streamlined efforts to boost national investment in domestic stocks.

Discounted redistribution

Introduced under Abenomics, the Bank of Japan’s ETF purchases are a legacy of the country’s deflationary era.

They’ve long helped to revitalise Japan’s corporate sector by lowering costs of capital. They’ve also seen the central bank become the largest shareholder of many major domestic blue-chip companies.

Following the Nikkei’s recent rally, analysts have even gone so far as to estimate that the value of the BoJ’s holdings are comparable to annual tax receipts for the whole of Japan.

So, what happens now?

Momentum around the idea of the Japanese government buying the central bank’s huge ETF holding at book value is growing. This would then offer the opportunity to distribute holdings to Japan’s younger generation at a discount.

When faced with the proposition last year, BoJ Governor Kazuo Ueda was somewhat cagey, calling the discussion premature. “When achievement of our price target is foreseen, we will debate specifics (of an exit policy) at our policy meeting and disclose the information,” he told parliament.

Elsewhere, further specifics from Governor Ueda around the form a sale might take have been limited largely to avoiding “losses at the BoJ” and “disruptive influences on the market”.

But we believe there is considerable merit to the approach suggested.

Distributing the BoJ’s ETFs back to Japanese citizens at a discount is in keeping with Japanese Prime Minister Fumio Kishida’s ongoing efforts to boost domestic investment.

Wealth distribution is among his party’s key policy agendas. In particular, the Prime Minister’s Doubling Asset-based Income Plan aims to bring household income from investment up to levels seen across the likes of the US and the UK.

Just in January, Japanese NISAs – an analogue to the UK ISA – were successfully expanded to encourage domestic retirement saving.

Alongside this, the redistribution of government ETF holdings among a domestic population already has successful precedent.

Back in 1998, the Hong Kong Government acquired a large portfolio of domestic shares to prop up the market during the Asian Financial Crisis. The following year, it created an exchange traded fund itself to offer residents an avenue to acquire these shares while creating minimal disruption in the market.

Fast forward 25 years to today, and the “Tracker Fund of Hong Kong” has helped the territory’s ETF market to become the fourth largest in Asia ex-Japan.

Streamlined approach

Whatever mechanism is chosen, using central bank ETFs to encourage domestic investment in domestic stocks seems pragmatic.

It builds not just on Japanese citizens’ expanded capacity for tax free investing, but also heightened interest in the stock market following the Nikkei’s record rally. Throw in an opportunity to enter the Nikkei at a discount, and there’s little more Japan’s government can do to encourage participation.

For existing investors in Japan, this is a bright prospect.

Stricter corporate governance standards are already ensuring their positions are becoming more valuable than ever. If citizens begin to transfer even a slightly larger portion of their famously large cash savings piles into the market than they do today, the growth capital unleashed could provide the spark needed to ensure sustained outsized returns.

Richard Aston is portfolio manager of the CC Japan Income & Growth Trust and the Chikara Japan Income & Growth Fund

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