The Bank of Japan (BOJ) continues to take an unconventional path of purchasing exchange traded funds (ETFs) that contain only Japanese companies in an attempt to improve investor confidence, promote economic growth, and to meet a targeted 2% inflation for Japan. Despite using this new central bank tool to purchase Japanese ETFs on such a large scale, the BOJ has produced questionably mediocre results whose long term implications are extremely uncertain.

The Japanese economy nearly stalled recently as Japanese GDP grew by an annualized 0.2 percent during the second quarter of 2016 instead of the predicted 0.7 percent increase. Business spending contracted for the second straight quarter of 2016 and exports continued to struggle due to a strengthening Yen. As Japan struggles to create new economic growth, many wonder if the production possibilities frontier and national GDP will ever expand for Japan. Innovation, corporate expenditures, and new discoveries that grants access to additional resources and technology that was previously inaccessible might be the answer for Japan. However, the distant future seems uncertain as Japan’s growth continues to stagnate and possible volatility of the Yen when stimulus packages and quantitative easing comes to an end.

The BOJ now owns approximately 55% to 60% of Japan’s ETFs, and has earned the nickname of “Japan’s ETF Whale” because BOJ is a top 10 shareholder in about 90% of Nikkei 225 stock average. The Japanese central bank (BOJ) now owns more Japanese ETF’s than both BlackRock Inc. and Vanguard group which are some of the largest asset class owners in the world. The BOJ shows no sign of slowing down the purchasing of domestically traded Japanese ETFs. Rather it is predicted by Goldman Sachs that the BOJ will accelerate and more than double its ETF purchase annually to an annual rate of 7 trillion Yen. This introduces an arbitrage opportunity for investors in the Japanese equities market and also ETF market by potentially purposefully limiting supply to drive up prices, and also hints at a temporary equities and ETFs appreciation for investors for the foreseeable short term future.

By purchasing Japanese ETFs, the central bank also helps to spur increased demand for the Yen in the global currency markets causing the Yen to temporarily appreciate in value given that the money supply is fixed. There is also much debate about the moral implications associated with artificially high equities prices (high equity valuations) in the Tokyo Stock Exchange due to increased demand for Japanese ETFs that contain those same equities. Artificially propping up equity asset prices invites the opportunity for long and short arbitrage positions.
Some ETFs work exploring in our ETFHeatMap database include:

  • EWJ – iShares MSCI Japan ETF
  • DXJ – WisdomTree Japan Hedged Equity Fund
  • HEWJ – iShares Currency Hedged MSCI Japan ETF
  • JPXN – iShares JPX-Nikkei 400 ETF

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