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BOJ's huge share purchases cause investor unease

Fund managers worry about distorted stock prices and weak market discipline

The Bank of Japan has sharply expanded its share buying campaign under Gov. Haruhiko Kuroda. (Photo by Taro Yokosawa)

TOKYO -- The Bank of Japan's stock buying program may be creating more problems than it solves, despite its goal of improving the nation's economy.

The BOJ has become a top 10 shareholder in 40% of Japanese listed companies according to calculations by Nikkei. But some fund managers have become alarmed by the resulting price distortions, diminished market discipline and other side effects.

The situation could be compared to drug use -- good in the short term, but addictive and hard to kick in the long term. Many people now see the need for an exit, but no one seems to know how to achieve one. 

"Nobody can see a smooth exit strategy," said Jesper Koll, Japan head of U.S. asset manager WisdomTree. By continuing with its stock purchases, the BOJ is creating "a new form of financial socialism," he said.

The central bank began buying stocks on a small scale in 2010, then ramped up its purchases in 2014 and 2016. It now owns about 4% of the Tokyo Stock Exchange's First Section. Fund managers say the BOJ is now a dominant player in terms of money flows.

The central bank already controls the Japanese government bond market following its 2016 decision to keep the 10-year yield at around zero. Trading activity largely dried up as a result

In the stock market, BOJ control hasn't reached that level. But Koll points out that the BOJ's program is eroding market discipline as companies are rewarded simply for being in major market indexes, rather than for having new business strategies or offering more dividends or share buybacks.

"Analysts are very frustrated -- their work on fundamental analysis has become more or less useless because all that matters is the BOJ-dominated index flows," Koll said.

The BOJ invests in equities through exchange-traded funds, or ETFs, which are ready-made packages of stocks created by asset managers to allow investors to make diversified investments.

The BOJ doesn't own the stocks directly. Rather, it owns them through a trust bank when it purchases ETFs. About 70% of the ETFs that the BOJ purchases are tied to the capital-weighted TOPIX index, which includes around 2,000 companies on the TSE's First Section.

Since 2016, the BOJ has been buying ETFs worth 6 trillion yen ($55 billion) a year. This was the amount of a selling excess on the TSE's First Section last year, meaning that without the BOJ buying, the selling excess would have been about double.

Some argue that the market impact of the BOJ program is still limited. HSBC Global Asset Management points out that Japanese equities remain undervalued relative to their peers, despite the BOJ's stock buying campaign.

Patrice Conxicoeur, chief executive of HSBC Global Asset Management (Japan), said the undervaluation may reflect factors such as a lack of faith in Prime Minister Shinzo Abe's growth plan, known as "Abenomics," uncertainty about the BOJ's exit policy, or Japan's demographic challenges. 

The asset purchase program has been carried out with the explicit goal of affecting the asset prices, Conxicoeur points out. "We don't really have problem with this in the sense that this is a stated policy and is happening in a transparent manner."

But he warns of side effects.

"One obvious side effect, which is not limited to Japan and true for every country where unconventional monetary policy is pursued for a long time, is that unconventional monetary policy proceeds through wealth effects, and evidently, wealth effects tend to increase inequality," he said.

"Another side effect is that if you have a very easy monetary policy for a very long time, some companies that should have died are kept alive," he added. "If you have many zombie companies, your productivity doesn't increase."

For now, though, Japanese companies seem comfortable with having the BOJ as a major shareholder.

Nikkei Asian Review contacted five companies in which the BOJ is the de facto largest shareholder  -- Tokyo Dome, Sapporo Holdings, Unitika, Nippon Sheet Glass and Aeon. Predictably, none offered any comment.

"Japanese companies are apparently okay with the BOJ as a major shareholder, as long as it helps keep their share prices up," said Keiichi Omura, professor of corporate finance at Waseda University.

Omura, however, is concerned about the complacency that the BOJ is encouraging at companies in which it invests. "The stimulus has stayed for so long that the market has started losing discipline," he said. With Prime Minister Abe keen to keep share prices high, the government and the industry are effectively in collaboration, he said.  

That puts the BOJ in a tight spot. It cannot strengthen market discipline without ending its share purchase program, but that could cause major disruptions in the market, Omura warned.

Most foreign fund managers seem to think tapering of the program is just a matter of time.

"Judging by the unintended consequences the purchase program has created ... the question is not if, but when they will announce the potential tapering," said Qian Wang, chief economist for Asia-Pacific with major global investment company Vanguard.

She cites corporate governance concerns, the crowding out of other investors, and risks to the BOJ's balance sheet as some of the consequences.

While Wang thinks a smooth tapering program is possible, others are not so sure.

"Global investors view the BOJ program as a structural impediment against investing in Japan," said WisdomTree's Koll. "Nobody wants to take the risk of holding Japanese stocks on the day the BOJ stops buying."

Unlike JGBs held by the central bank, which eventually mature and roll off the balance sheet, equities have no maturity dates. They must be sold to someone to be removed from the balance sheet. The question is -- to whom?

HSBC's Conxicoeur said there is an overseas precedent for a smooth exit.

During the Asian financial crisis of 1997, The Hong Kong Monetary Authority bought a large amount of Hong Kong shares to counter speculative selling.

The HKMA faced criticism that it was manipulating the market and became a large shareholder of many listed companies. But the authority eventually created a mechanism to dispose of its massive shareholdings through ETFs.

Could investors be convinced to buy the assets that the BOJ wants to divest in similar way? Would asset prices collapse?

"Whoever designs that exit scheme will deserve the Nobel Prize for applied economics," Koll said.


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