BOJ ‘Absolutely Certain’ to Stop Buying Nikkei ETFs, CLSA Says

(Bloomberg) -- Nicholas Smith of CLSA Ltd. says he’s “absolutely certain” the Bank of Japan will stop buying exchange-traded funds tracking the Nikkei 225 Stock Average amid criticism its use of the measure is distorting the market.

The central bank will make the change at its meeting next week, shunning ETFs following the price-weighted stock gauge in favor of those linked to more modern indexes, Smith said. He says he’s been talking to BOJ officials within the last three days, while declining to name them. BOJ board members have made no public indication of an impending shift in the ETF program ahead of announcing their monetary policy review on Sept. 21.

The Nikkei 225 gives undue influence to certain stocks because it determines its rankings by the price of one share, rather than market capitalization. Fast Retailing Co., for example, accounts for 8 percent of the gauge, versus just 0.3 percent of the Topix. That means it benefits disproportionately from the central bank’s Nikkei 225 purchases. Since the BOJ almost doubled its annual budget for ETFs on July 29, the issues associated with the Nikkei 225 have become more pronounced, Smith said.

“I am absolutely certain that they will shift their buying to pretty much Topix-based,” Smith, a Tokyo-based strategist at the brokerage, said by phone Friday. “The Nikkei 225 is a Flintstones index from the abacus era,” he said. “It’s been a laughing stock for a long time.”

Mostly Nikkei

The BOJ seeks to spend 6 trillion yen ($58.9 billion) a year on ETFs tracking the Nikkei 225, Topix and JPX-Nikkei Index 400. Under its rules, it buys funds in proportion to their market value. As Nikkei 225 ETFs are most prevalent in Japan, they account for about 55 percent of the BOJ’s purchases, according to Smith.

This will fall to “something close to naught,” said Smith. Rather than reducing overall purchases, they’ll just buy the Topix and JPX-400 instead, he said.

The Nikkei 225 has lost 13 percent this year, beating a 15 percent drop for the Topix.

The BOJ’s ETF buying is part of a package of unprecedented stimulus aimed at revitalizing the economy. The central bank is due to reveal the results of its policy review after the two-day meeting ends.

The BOJ was already a top-five owner of 81 companies in the Nikkei 225, according to estimates compiled by Bloomberg from the central bank’s exchange-traded fund holdings last month. The bank owned about 62 percent of Japan’s domestic ETFs at the end of July, according to Investment Trusts Association figures, BOJ disclosures and data compiled by Bloomberg.

“They will buy the Topix, which is the neutral, fair, equitable choice,” Smith said.

To contact the reporters on this story: Anna Kitanaka in Tokyo at akitanaka@bloomberg.net, Toshiro Hasegawa in Tokyo at thasegawa6@bloomberg.net. To contact the editors responsible for this story: Jeff Sutherland at jsutherlan13@bloomberg.net, Tom Redmond