What Happens When Central Banks Become Major Buyers in the Stock Market? Case Study: Japan

The Bank of Japan decided at its July 28–29 meeting to boost its purchases of exchange-traded funds (ETFs) to an annual rate of 6 trillion yen, almost double the previous rate of 3.3 trillion yen. The BOJ began its ETF purchasing in October 2010 at a much more modest annual pace of roughly 450 billion yen. The rate was doubled to 1 trillion yen a year in April 2013 and increased further to around 3 trillion a year in October 2014. As a result of the latest doubling of the BOJ program, BOJ purchases are averaging 2.9% of daily trading values, doubling the previous average.

The ETF purchase program has the apparent objectives of improving market confidence and stimulating consumer and business spending. Its success so far in furthering those objectives has been modest at best. However, equity prices are surely higher than they would have been in the absence of these purchases. In the future, as the BOJ’s ETFs can and probably will be held by the Bank indefinitely, they will likely provide continuing psychological price support for the market.

The BOJ is buying ETFs that track the TOPIX, the Nikkei 225 Stock Average, and the JPX-Nikkei 400. The proportions of the total purchases accounted for by these three indexes have been based on market capitalization: respectively, 54%, 42%, and 4%. In May the BOJ also started buying new ETFs that include companies that are “proactively making investment in physical and human capital.” The plan is to purchase 300 billion yen of such ETFs a year as part of the overall ETF program, but investors have been reluctant thus far to purchase the six new ETFs launched since May 19. Note that the BOJ is limited to holding no more than 50% of any ETF.

The BOJ does not buy individual shares directly. Nor does it buy ETF shares that are on the market. When it places an order for an ETF, the ETF share is newly created by an asset management company, using a basket of shares purchased by a securities company. Thus, the BOJ is not limited by the outstanding volume of ETFs in the market.

Views are mixed about what Bloomberg calls “the Bank of Japan’s controversial march to the top of shareholder rankings in the world’s third-largest equity market.” Goldman Sachs Investment Research estimates that the BOJ’s current holdings of ETFs are about 70% of the total market cap of ETFs eligible to be purchased and that under the latest expansion of the program, the BOJ’s indirect holdings of TOPIX stocks will reach “3.25% of market cap, or 5.1% adjusted for free float.” Bloomberg estimates that by 2017 the BOJ will be the top shareholder in about a quarter of the Nikkei 225 companies. While so far the BOJ’s purchasing activities do not appear to have affected the market’s smooth functioning, this could change as these activities increase.

Investors welcome the strengthening of share prices likely to result from the increased share purchases. There are some potential negative side effects that are a medium to long-term concern. Goldman Sachs Investment Research notes two concerns that we share. First, the purchases cover broad indexes that include the shares of some companies that do not deserve to have their share prices boosted, companies whose shares may already be overvalued. In other words, the purchases will likely create market distortions that could become significant. The second concern is a likely weakening of corporate governance, which would conflict with the Abe government’s reform efforts to strengthen corporate governance instead. As for shares held in BOJ-owned ETFs, we have doubts that shareholder voting rights will be exercised properly by the asset management companies holding those rights.

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Chief Global Economist
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