The Bank of Japan owns around ¥70 trillion ($475 billion) of the country’s exchange-traded funds, a legacy of its decades-long campaign to help defeat deflation by pouring money into the equity market. With the BOJ set to raise interest rates as higher prices ripple through the economy, a key question for stock investors is what policymakers plan to do with this enormous pile of funds, and when. Reducing it would help the central bank normalize one of the most unorthodox parts of its policy regime. Yet this would risk undermining confidence in a stock market that only just clawed itself back to levels last reached in 1989.
1. What are the options?
At one extreme, the BOJ could start selling its ETFs right away, an unlikely scenario as it risks dragging the stock market down at a delicate moment in Japan’s economic turnaround. At the other end of the spectrum, it could just stop buying, hold forever what it owns now and keep raking in the dividends, which are a big part of the central bank’s earnings. A widely expected scenario is for the BOJ to pause, then begin a long and gradual sell-down over years or decades.
Experts have offered a host of more creative solutions. One is for the government to take over the ETFs and issue perpetual bonds to the BOJ to move the funds off the bank’s balance sheet. Japan could also gift a portion of the ETFs to young adults to boost their securities ownership, according to Nomura Research Institute Ltd. analyst Katsutoshi Takehana.
Another option would be for the BOJ to replicate what Hong Kong did after its stock market intervention in 1998, disposing of its holdings by pooling them into a new listed vehicle, Goldman Sachs Group Inc. economists wrote in a 2018 report. Japan could also create an entity to sell into the market at opportune times, or offer them to long-term institutional investors off the market, they wrote.
2. What are the market implications?
They may be immense. The BOJ holds the equivalent of about 7% of the Japanese stock market via ETFs, according to data compiled by Bloomberg. If the bank decides to sell ETFs to realize profits, “huge sell orders could collapse market prices,” Daiwa Securities Co. analyst Ryohei Yoshida wrote in a report. That may damage not only the overall Japanese stock market, but hit some individual company shares especially hard. A weaker stock market would also risk eroding investors’ enthusiasm for efforts to normalize Japan’s monetary policy.
Before the central bank changed its guidelines in 2021 to buy ETFs tracking just the broader Topix index, it put massive amounts into the narrower Nikkei 225 of Japan’s heavyweight companies. Uniqlo operator Fast Retailing Co. has already shown itself to be one of the major firms that are sensitive to tweaks to the BOJ’s ETF policy.
3. What hints have been dropped on timing?
The central bank refrained from buying ETFs on March 11, a surprise departure from its usual playbook of buying when the market falls by 2% or more in the morning session. That may suggest Governor Kazuo Ueda is laying the groundwork for a shift, but he has also reiterated his view in Parliament this year that a decision on ETFs can wait until after its target for stable inflation comes within sight. Ueda has repeatedly said that it’s too early to discuss how ETFs could be unloaded.
4. Why did the BOJ start buying ETFs in the first place?
The BOJ began purchasing ETFs to revitalize Japan’s corporate sector, lowering the cost of capital by making more funds available and encouraging more risk-taking activity in the economy. It was the only major central bank to use ETF buying as a way to pump cash into the economy. Asset purchases that began before Haruhiko Kuroda took the helm in 2013 grew rapidly under his leadership. The ETF purchases initially helped to prop up shares, with the Nikkei advancing 57% in 2013, but their effect waned over time. Buying peaked in 2020 as part of measures to support the market amid volatility caused by the pandemic.
5. How much are the BOJ’s ETF holdings worth now?
The bank held about ¥70 trillion as of February, with around ¥34 trillion of unrealized gains, according to estimates from Shingo Ide, chief equity strategist at NLI Research Institute. The central bank bought ETFs only three times last year, a small fraction of purchases conducted in 2020 and earlier, Bloomberg-compiled data show.
6. Why are the holdings criticized?
A big criticism is that the BOJ’s huge purchases and holdings distort the market. That can spark outsized moves on any change in policy, such as in 2021 when the BOJ shifted from the Nikkei to the Topix. The change led to a 6% drop in the Nikkei in the next four sessions. Fast Retailing, which has the index’s biggest weighting, sank 14%. The BOJ’s holdings reduce shares available for investors to buy and make it harder for shareholders to influence corporate governance. The phenomenon may continue to hold back growth in Japan’s ETF market compared with the rest of Asia-Pacific, Bloomberg Intelligence ETF analyst Rebecca Sin wrote in a report.
This article was provided by Bloomberg News.