Masaryk University
Faculty of Economics and Administration
Field of study: Finance
ANALYSIS OF THE JAPANESE INDICES
Analýza japonských indexů
Bachelor thesis
Thesis supervisor:
Author:
doc. Ing. Martin SVOBODA, Ph.D.
Sabina BINZARU
Brno, 2014
Author’s name and surname:
Sabina Binzaru
Name of bachelor thesis:
Analysis of the Japanese indices
Department:
Finance
Bachelor thesis supervisor:
doc. Ing. Martin SVOBODA, Ph.D.
Year of defense:
2014
Annotation
This bachelor thesis focuses on the Japanese stock indices, particularly on Nikkei 225 and TOPIX. The
main goal of the thesis is to analyze the main characteristics of the previously mentioned indices, evaluate
and compare their way of construction, regard the possibility of index investing and formulate
recommendations on this issue. The thesis consists of four chapters; the first chapter makes an introduction
to indices mentioning their history, fundamental uses and factors of relevance. The second chapter focuses
on index construction taking into account weighting, calculation and adjustment methods. The third chapter
briefly introduces Japanese stock indices and then analyzes and compares the chosen Japanese indices from
different perspectives. The last chapter is aiming at describing index investment opportunities and risks and
discovering and comparing index investing products that have Nikkei 225 and TOPIX as underlying.
Anotace
Tato bakalářská práce se zaměřuje na japonských akciových indexů, zejména na Nikkei 225 a TOPIX.
Hlavním cílem práce je analyzovat základní charakteristiky výše uvedených indexů, hodnotit a porovnávat
jejich způsob konstrukce, možnost investování do indexů a formulovat doporučení týkající se této
problematiky. Práce se skládá ze čtyř kapitol; první kapitola je úvodem do indexů zmiňující jejich historii,
základní použití a faktory které ovlivňují vypovídací schopnost indexu. Druhá kapitola se zaměřuje na
konstrukce indexů berouce v úvahu způsob vážení a metody kalkulace a úpravy. Třetí kapitola stručně
představí japonské akciové indexy a následně analyzuje a srovnává vybrané japonské indexy z různých
pohledů. Poslední kapitola je zaměřená na popis investiční příležitosti a rizika investování do indexů a
zjištění a srovnání investičních produktů, které mají Nikkei 225 a TOPIX jako podkladové aktivum.
Keywords
Index investing, Nikkei 225, TOPIX, Free-Float Value, Tokyo Stock Exchange
Klíčová slova
Indexové investování, Nikkei 225, TOPIX, Free-Float Value, Tokyo Stock Exchange
Declaration
I declare that I have been working on the thesis Analysis of the Japanese Indices individually under the
supervision of doc. Ing. Martin Svoboda, Ph.D. and I have mentioned all the literary and other specialized
sources in compliance with the legal regulations, internal regulation of Masaryk University and internal
proceedings of Masaryk University and of the Faculty of Economics and Administration MU.
Brno, April 10, 2014
…………………………………
Author’s signature
Acknowledgements
I would like to express my gratitude to doc. Ing. Martin SVOBODA, Ph.D. for all the time devoted to my
thesis, for his valuable advice that has helped me to develop this work and for all the things taught during
the Financial Markets course. I would also like to thank my Japanese teacher, Kohshi Hirayama for helping
me to better understand the geopolitical and financial situation of Japan in the last centuries.
Contents
Introduction
Chapter 1
8
General index characteristics
9
1.1
Definition and short history
9
1.2
Fundamental uses of indices
10
1.3
Factors of relevance
11
Chapter 2
Index construction
12
2.1
Key criteria for an effective index
12
2.2
Index weighting methods
13
2.3
Index construction guidelines
14
2.4
Index adjustment
16
2.5
Free-Float Weight
17
Japanese stock indices
18
3.1
Japanese stock indices
18
3.2
Nikkei Stock Average
19
3.3
TOPIX
21
3.4
Japanese indices comparison
24
3.5
The joint index JPX-Nikkei Index 400
28
Index investing
30
4.1
Index investing – active vs. passive
30
4.2
Factors contributing to the growth of indexing
31
4.3
Index investment opportunities
32
4.3.1
Index funds
33
4.3.2
Index certificates
35
4.3.3
Index products
36
4.3.3.1
Exchange-traded funds
36
4.3.3.2
Index derivatives
37
4.3.3.3
Choosing among index products
39
Chapter 3
Chapter 4
4.4
Nikkei 225 and TOPIX investing
40
4.5
Index investing comparison
42
Conclusion
45
References
46
List of graphs
49
List of tables
49
List of pictures
49
List of annexes
50
Introduction
Being a significant, powerful equity market in the world, Japan has always deserved attention from local
and international investors. As following the evolution of each security is a long and intricate process,
there are stock indices that help investors understand the economic situation of Japan. There are two major
indices that are calculated in this country – Nikkei 225 and TOPIX, both of them being followed on
international scale.
The main goal of this thesis is to focus on the analysis of the Japanese stock indices evaluating their
method of construction and providing recommendation on index investing. As these two indices are
constantly competing for superiority, I have decided to research this aspect and to present arguments why
a certain index is better than the other and in which cases. Besides studying their method of construction, I
have also compared several financial instruments having those indices as underlying.
The first chapter is dedicated to the overall characteristics of a stock index, mentioning its definition and
brief history, its fundamental uses and the factors that make it relevant. The second chapter is focusing on
index construction, high lightening the key criteria for an effective index, possible methods of weighting a
stock, some essential guidelines for building an index, the techniques of adjusting it due to changes on the
stock market and the concept of Free-Float Weight.
The third chapter represents the core of the practical part of this thesis. It begins by briefly introducing the
indices calculated on Japanese stock market in Japan and overseas. It follows with the detailed analysis of
Nikkei 225 and TOPIX index construction according to general criteria like structure, constituents’
changes, calculation method, evolution, etc. In the next subchapter a complex comparison of these two
indices will be developed, regarding their performance, usage, composition, sector weight, calculation and
adjustment methodology. Lastly, I have included information about a new joint index calculated in Japan,
which represents a very interesting combination of different features of those two indices.
The last chapter concentrates on index investing possibilities and provides examples of ways to invest in
Nikkei 225 and TOPIX. A description of index investing strategy, the factors that have contributed to the
growth of indexing worldwide, an array of index investing opportunities and finally, a practical
comparison between index certificates and ETFs on these two indices will get us closer to the main aim. In
order to fulfill it, I have used the following methods: analysis, synthesis and comparison.
8
Chapter 1
1.1
General index characteristics
Definition and short history
The very used on the financial markets term of index can be defined as following: “an agregate indicator,
which informs about the overall evolution and situation on the market (market index) or in a certain
sector (sector index)“.1 Grace to the fact that an index concentrates in one number the evolution of a
certain range of securities it serves as an indicator of the whole market.
The idea of creating an indicator that would inform about the market situation was born in the United
States in the nineteenth century. In 1884, Charles Dow, the founder of Wall Street Journal, together with
Edward Davis Jones have published for the first time the Dow Jones Average Index. This index included
11 companies operating in the railroad sector which were given weight in the index according to their
share price. Their main aim was to provide investors through an indicator a general overview of the
market situation. A few years later, in 1896, Dow Jones decided to separate the railroad stocks in a special
index (Transportation Index) and to create a new industrial average index based on 12 stocks. The
publication of Dow Jones Industrial Average began on May 26, 1986. Nowadays, it comprises 30 stocks
and remains one of the few price weighted indices.2
A revolutionary year in index history was 1923, when for the first time Standard Security Corporation
(now Standard & Poor’s) has created the first index based on market capitalization weighting. Even if at
the beginning it included only 90 securities, it expanded over years reaching a value of 500 securities in
1957. Grace to its complexity, it was regarded as the index that best represents the U.S. equity market.
That is why both the first retail index fund created in 1976 by Vanguard and the first exchange-traded
fund established in 1993 by State Street Global Investors have selected it as their benchmark.3
Since then, the world of indices has considerably evolved. New techniques for index calculation and
adjustment appeared, and what is more important, a vast range of index-based products have seen the
light. There are several types of indices if we speak about the securities incorporated in it, so that we have
stock indices, bond indices, commodity indices, etc. However, the most frequently used and important are
stock indices, on which I am going to focus my attention in this thesis.
1
VESELA, Jitka. Investování na kapitálových trzích. Prague: ASPI, 2007. 704 p. ISBN 978-80-7357-297-6, p. 75.
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, p. 14.
3
FERRI A., Richard. The power of passive investing: more wealth with less work. Hoboken, New Jersey: John Wiley and Sons,
Inc., 2011. 264 p. ISBN 978-0-470-59220-5, p. 10.
2
9
1.2
Fundamental uses of indices
Stock indices are calculated all over the world and represent different possible markets such as countries,
regions, assets classes, etc. Indices became primordial in the investment industry and their usage is
appreciable. In his book Active Index Investing, Schoenfeld defines four major key uses of indices, which
are:
a) Gauge of public or market sentiment
From the moment of their creation, indices have been primarly used to define the overall situation of a
market in a certain moment. The users of the first index in the world, Dow Jones could understand the
market situation grace to a single number that reflected the impact of the factors influencing stocks’ price.
If speaking about the nature of those factors, they were not only the ones related to the performance of the
companies included in the index. They tend to be broader, as factors like upcoming wars, conflicts,
recession, economic expansion also affect the stock price. This function is especially noticeable in
stressful times when an index by its value indicates the market sentiment.
b) Performance measurement
Having an available, appropriate index has been from the very beginning of its creation a widely used
instrument to measure performance, compare and evaluate the work of a manager. Most professionals
activating in the investment industry consider that measuring the performance against a benchmark is
vital. It is right that benchmarking allows investors to monitor the performance of a manager and even
helps them with the decision of hiring or firing him. Undoubtedly, benchmarking helps identifying
managers able to generate higher revenues. However, we should not forget about the time horizon if we
want a sustainable good preformance rather than focus on short-term successful performance of certain
asset managers. That is why the decision making process should be regarded in a long-term perspective,
which should not be underappreciated.
c) Measuring asset class performance and setting assset alocation policy
The information a well-constructed index can provide about a particular asset class performance is
extremely valuable. It shows the behavior of a security or an asset class over time and allows the
calculation of long-run rates of return. In addition, index permits to calculate the risk and the changes in
risk of an asset class, correlations and other indicators relevant for the investment and asset allocation
policy.
10
d) Indices as the basis for investment vehicles
Taking into account several theories that proved the difficulty to beat the market with low risk, there has
been developed an interesting alternative called index funds. Beside being a low-cost option for investors,
it also reduces their stress of investing in high-cost funds that might underperform and do not meet their
expectations. Moreover, another revolutionary concept called index-based products gains popularity due
to its easy-to-follow technique and transparency for investors.4
1.3
Factors of relevance
In order to have a relevant index that will provide us real, current and trustworthy information about a
chosen market or sector, there are several factors that should be taken into account. The first thing to
consider is the base dimension (or the number of securities in the base of the index). If we want the index
to reflect the economic situation of a country for instance, we have to include in its base as much
securities as possible. However, one has to consider that calculating an index with a big number of titles
(securities) is costly and difficult, that is why it is optimal to find a rational number of representative
securities and to follow them. Another important factor is the representativeness of the base, as an index
has to incorporate securities of companies from different sectors and with different market capitalization if
it wants to be closer to the market situation.
In order to make an index easy to interpret and follow, it is reccomendable to keep it in units that are
comprehensible and comparable. As an index has to be as close as possible to real market situation, it has
to be updated daily and made available to public regularly. As for the technical aspect, if an index is
calculated based on the mean, it is essential to decide if to use either the arithmetic or the geometric mean.
Compared to the simple arithmetic mean, the geometric one has the capacity to smooth the excessive
fluctuations of index data.5
4
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, pp. 65-73.
5
VESELA, Jitka. Investování na kapitálových trzích. Prague: ASPI, 2007. 704 p. ISBN 978-80-7357-297-6, pp. 77-78.
11
Chapter 2
2.1
Index construction
Key criteria for an effective index
An investor chooses an index to follow according to his array of needs. This choice is sometimes difficult
that is why he has to look at the characteristics of the index and see if it provides the required information.
However, there are several main criteria to define a well-constructed index. Schoenfeld defines seven of
them, which are:
1) Completeness – meaning that an index has to reflect a wide range of investment possibilities. It has to
take into account both the territorial factor and the choice of which companies to include. Schoenfeld
assumes that this is the most significant criterion, as the more an index manages to cover the targeted asset
class, the bigger is its utility for investors following this index.
2) Investability – questionning if an index includes all the listed stocks of a company or just those stocks
that are publicly available. The investability criterion comes in contradiction with the precedent criterion,
so an investor has to make a choice between a complete index and an index who reflects the situation of
only purchasable stocks.
3) Clear, published rules and open governance structure – showing the importance of having wellestablished and clear rules based on which the index is constructed. The calculation methods of the index
have to be comprehensible and, in addition, always publicly available.
4) Accurate and complete data – pointing out the quality of the data included in the index. Besides
being accurate and complete, a minimum set of information related to the constituents of the index, which
might suffer some changes over time, and the source of the data used should be publicly available.
5) Acceptance by investors – supposing that it is not enough for an index to be calculated, but also to be
accepted and used by investors.
6) Availability of crossing opportunities, derivatives and other tradable products – implying that an
index should be the right tool for index-based products. Index is playing as well an outstanding role in
crossing opportunities, which allow matching buyers and sellers with considerably lower costs.
12
7) Relatively low turnover and related transaction costs – meaning that it is preferable for an index to
have lower turnover (less changes in its consitutents), thus not generating huge, costly rebalancing costs
for the organization that is calculating it.6
2.2
Index weighting methods
There are different ways of attributing a stock its weight in a certain index. According to the weighting
type of index construction, we can distinguish three major groups of indices, which are: price weighted,
value (or market cap) weighted and unweighted stock indices.
In a price weighted stock index, the price of its stocks (components) is the only thing that influences the
index trading price. This obviously means that the stocks that have a higher price will have a bigger
capacity to influence the index than the ones that are traded cheaper. In spite of this fact, two of the most
important stock indices, Dow Jones Industrial Average and Nikkei 225 are calculated after this method.
When speaking about the value weighted index, another important parameter is included. The weight of a
stock in the index is determined by the price of the stock multiplied by the number of outstanding shares
(market capitalization). In this case, the companies with a larger market capitalization will have a bigger
impact on the movements of an index.
Lastly, an alternative of the weighted indices are the unweighted stock indices. All the titles included are
given the same weight. This method leads that each title will have the same effect on the index regardless
its market capitalization or price.7
Choosing the best method of construction is controversial as all of them have their light and dark sides. If
considering the value weighted index, it is clear that the market capitalization of a company is a
significant indicator. However, it tends to give priority to big companies and reduce the importance of the
smaller ones. Another important point to mention is that in some countries (e.g. Czech Republic, Austria)
a small group of companies operating in key sectors represents the biggest part of the index, limiting the
importance of smaller companies. A solution to this problem is implemented for example by the German
DAX, which established a limit of 10 % per each title. A different option to solve this issue it to use the
free-float adjustment technique, which defines how many stocks are publicly available, so giving a better
6
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, pp. 82-85.
7
KENNEDY, Mark, 2014. Different types of weighted indexes. Exchange traded funds [online]. Available at:
http://etf.about.com/od/etfbasics/a/Different-Types-Of-Weighted-Indexes.htm [Accessed 22 February 2014].
13
reflection on the situation of a component in the index.8 This technique is going to be discussed in details
a few chapters below.
After agreeing that the price weighted indices give preference to high-priced stocks and that value
weighted indices advantage the companies with high market capitalization, we might think that equal
weighted indices (unweighted) is a good replacement option. However, this conclusion is wrong. First of
all, the equal weighted index implies a too frequent rebalancing procedure needed to maintain the weight
of each stock due to its usual change in price. Secondly, giving the same importance to each company
would be inapproprite, as each company has a different contribution to economics. This would also mean
that the amount appointed to each sector of economics depends only on the number of companies of the
same sector chosen to be included in the index. Therefore, if an index comprises a considerable number of
small companies from one sector and only a few big companies from another, the first sector will be
overrepresented in the index. Lastly, the differences in the size and capital absorbtion possibilities of the
companies just make impossible the operation of such an index on a very large scale.9
2.3
Index construction guidelines
Since the creation of the first index Dow Jones Industrial Average, there have occured multiple changes
and improvements in the world of benchmarks. After understanding that a price weighted index is not
properly reflecting the investment universe, a big attention was devoted to value weighted indices. But his
switch was not enough. In the second decade of the 1970s, investors and managers claimed that broader
indices comprising a huge amount of stocks (such as Standard & Poor’s 500 Index or Russell 3000 Index)
do not fit their needs. They have emphasized the importance of creating indices according to different
investment styles and capitalization cathegories.
Since that period, a variety of indices has appeared, aiming at reflecting every sector, industry or
subindustry. Interesting is the fact that the methodology of calculating an index has much to say about the
index result. It happens that two different indices that are calculating the evolution of the same market
sector can deliver different outcomes.
A crucial idea about the creation of indices is mentioned in the article of Gus Sauter called Index Rex,
where he underlines the importance of having a replicable index. He mentiones that the best index is the
one that that measures the performance of the strategy chosen to reflect and not the one that gives the
8
Value weighted stock index: construction, problems and adjustments. Macroption [online]. Available at:
http://www.macroption.com/value-weighted-stock-index-construction-problems-adjustments/ [Accessed 22 February 2014].
9
ARNOTT D., Robert; HSU C., Jason; WEST M., John. The fundamental index: a better way to invest. Hoboken, New Jersey:
John Wiley and Sons, Inc., 2008. 311 p. ISBN 978-0-470-27784-3, pp. 68-71.
14
highest return. In order to create such an index, he proposes several key rules that would lead to a better
index construction. First of all, he accentuates the objectivity and the rule-based approach of choosing the
stocks in the index. Even though obeying a set of rules can generate higher turnover and needed
rebalancing costs, it is still fundamental to maintain the style integrity of an index and do not fall in the
trap of subjective decisions.
The weighting system deserves a special attention in connection with the investability criterion. When
choosing which company should be included in an index, we have to consider all the company’s
outstanding shares, as the size and importance of the company is influencing the performance of the stock.
However, when attributing this company its weight in the index, it is highly reccomendable to revise the
number of stocks that are actually available to the investment public (the so called free-floating criterion).
Not negligeable is the concept of the relativity of the market capitalization. The majority of the indices
today are value weighted, which means that the market capitalization is the key factor and has to be
periodically reviewed to reflect the performance of the chosen segment. However, Sauter proposes the
idea of considering the market capitalization as a relative indicator, thus reducing the rebalancing costs
generated by a possible new weighting of the company. This means that there should not exist a precise
boundary, for instance, between a large-cap and a mid-cap. A stock should migrate from one cathegory to
another only if compared to others it changes its position but not in case all of them proportionally do so.
This practice reduces the turnover and offers investors a better understanding of companies’ classification.
Last but not least, is the comprehension of two terms considered complementary – value and growth
stocks. It is erroneous to think that a stock can be only either value or growth. When evaluating a stock,
value managers and growth managers pay attention to different indicators (price/earning, price/book,
dividends for value managers and earning, sales, margin growth for growth managers). Their analysis can
conclude the existence of pure value or pure growth stocks, but also of neither value nor growth and both
value and growth stocks. A style-based index has to take into consideration these combinations, rather
than strictly delimitate between value and growth stocks.10
10
SAUTER, Gus, 2002. Index Rex. Journal of indexes [online]. Available at:
http://www.etf.com/publications/journalofindexes/joi-articles/1411-index-rex.html?fullart=1&start=6 [Accessed 21 February
2014].
15
2.4
Index adjustment
As previously mentioned, indices should be regularly updated. The constantly changing situation on the
market and the occurance of different events should be reflected in the index. Some of the most important
adjustments an index suffers are:11
a) Change of basis
Changes in the basis of an index are caused by factors of different nature, for example changes in the
economics of a country, sector changes (new creation and dissapearance of companies or sectors) or
company changes (changes in the market capitalization of a company, augmentation or decline of traded
stocks). An index should adapt in order to be as close as possible to the market reality.
b) The split
Stock split is a method when a stock with a bigger nominal value is split into several stocks with a smaller
nominal value. From an investor’s perspective who owns a particular number of stocks, splitting does not
affect the total assets’ price, in spite of the increased number of stocks and their different price. Usually
companies use the method of splitting their stocks either when their stock price is relatively high, thing
that makes them less liquid or when they expect a positive future profit.
The process of splitting depends on how an index is weighted. In case of price weighted indices the split
causes an interesting effect. It gives importance to unsplit stocks and disadvantages the split ones, which is
an irracional result. In case of the value weighted indices the result is favorable. As splitting does not
influence the whole market capitalization of the company and the new prices mutually compensate with
the new number of stocks, there are no changes in the index. On the other hand, one can expect that
splitting might have a positive effect on the market (due to the increased liquidity), thus causing the rise of
the stock price.
c) Stock replacement
Stock replacement is a common procedure due to mergers, takeovers, listing or delisting of a certain
company. The replacement can have various effects on the value of the index as new securities of the
included companies might behave different from the old ones.
11
VESELA, Jitka. Investování na kapitálových trzích. Prague: ASPI, 2007. 704 p. ISBN 978-80-7357-297-6, pp.80-82.
16
2.5
Free-Float Weight
The Free-Float Weight (FFW) represents the weight of the total listed shares that are available to the
investing public. It is an important criterion used by a significant number of indices. The calculation of the
free-float value begins by the estimation of the non-free-float shares, which are the shares that are not
freely available to the public. The data about the non-free-float shares can be extracted from the securities
reports or from the documents that are published by the listed companies. The FFW is calculated using the
formula below and it can reach a value between 0.00000 and 1.000000.
FFW = 1* (1- Non FFW),
where Non FFW represents the result of Non-Free-Float Shares divided by the number of listed shares.12
12
Tokyo Stock Exchange, 2012. Tokyo Stock Exchange Index Guidebook. [pdf] Tokyo: Tokyo Stock Exchange. Available at:
http://www.tse.or.jp/english/market/topix/b7gje60000003v3u-att/b7gje60000006cm3.pdf [Accessed 20 December 2013].
17
Chapter 3
3.1
Japanese stock indices
Japanese stock indices
Stock indices began being calculated in Japan after the Second World War. Their importance go further
Japanese market and they are widely used all over the world. Due to the complex stock market, there are
different types of indices calculated in Japan, taking into consideration aspects like size, style, strategy,
sector, etc. This thesis focuses on the most popular Japanese indices which are Nikkei Average and
TOPIX. It is important to mention that due to limited space only the “classic” version of these two indices
is going to be analyzed. Each of these indices has sub-indices and other indices that derive from the initial
version.
Tokyo Stock Exchange (TSE) is the institution that nowadays calculates over 15 different main indices
tracking different types of stocks. Beside TOPIX, which is calculated from the stocks on the First Section,
TSE calculates indices based on shares from the Second Section, the Mothers market, the JASDAQ
market and REIT market. It has also a wide variety of sector and market capitalization-based indices.
Among price indices, TSE calculates several performance indices, which take into consideration
dividends.13 Annex A offers a better comprehension and a complete image of the indices calculated by
TSE.
Nihon Keizai Shimbun (Nikkei Inc.) is a leading economic newspaper in Japan that publishes one of the
most important and old indices in the world, Nikkei Stock Average (known as Nikkei 225). Except the
main index, it calculates Nikkei derived indices and other indices based on criteria like dividend
investment, strategy, volatility, as well as bonds and commodity indices. 14 Annex B gathers all the indices
calculated by Nikkei Inc. at the moment.
There are also indices such as MSCI Japan Index and the FTSE Japan, who track Japanese stock market
but that are calculated by foreign financial institutions.15
13
Indices. Tokyo Stock Exchange [online]. Available at: http://www.tse.or.jp/english/market/topix/index.html [Accessed 30
March 2014].
14
Nikkei Indexes. Nikkei Indexes [online]. Available at: http://indexes.nikkei.co.jp/en/nkave/index [Accessed 30 March 2014].
15
ENDO, Nobuya, 2013. Japanese benchmarks The Nikkei and the TOPIX Face-off. [pdf] State Street Global Advisors.
Available at:
http://www.ssga.com/library/povw/516936_Japanese_Benchmark_The_Nikkei_and_the_TOPIX_Face_OffCCRI1362694345.p
df [Accessed 20 February 2014].
18
3.2
Nikkei Stock Average
Introduction
The calculation of the world-wide popular index, Nikkei Keikin Kabuka16 (called Nikkei Average or
Nikkei 225) began on September 7, 1950. At the beginning, Nikkei 225 was retrospectively calculated
back to May 16, 1949, date that marks the reopening of Tokyo Stock Exchange after the Second World
War. Initially, it had been calculated by Tokyo Stock Exchange (TSE). However, since 1970, the
economic newspaper Nihon Keizai Shimbun was the institution in charge of calculating it.17
Constituents
Nikkei Stock Average consists of 225 domestic common stocks listed in the first section of Tokyo Stock
Exchange. The index does not include ETFs, REITs, preferred securities, preferred stocks or tracking
stocks.18 Nikkei has 6 main sectors and 36 subsectors. For a detailed Nikkei’s sector and subsector
classification and the number of titles included in each of it see Annex C.
Constituents’ changes
The constituents are subject to a “Periodic Review” and an “Extraordinary Replacement” review. The
Periodic Review takes place once a year at the beginning of October and its main goal is to maintain the
market representativeness of its components by making any changes needed.
After this revision, stocks with high liquidity may be added, while the less liquid stocks may be removed
from the index. The liquidity of a stock is judged according to two indicators: trading volume and
magnitude of price fluctuation by volume, the latter calculated as (high price/low price)/volume. The
procedure of selecting liquid stocks comes in two phases. First, there are chosen 450 top liquid stocks of
the first section of TSE, the so called “High Liquidity Group”. If any current component does not figure
on this list, it is removed from the index. Second, another list of top 75 most liquid stocks from first
section of TSE is created. If any of those extremely liquid stocks ranked 75th or higher is not yet in the
index, it is included.
However, liquidity is not the only criterion of including or deleting stocks in Nikkei 225. The Periodic
Review regards the aspect of sector balance, based on the number of constituents in each sector, so that
none of them is over or under represented. Technology and Materials sectors are the most represented in
the index if judging from the number of companies. This was to be expected as Nikkei was primarily
16
Keikin Kabuka (jp) means “Average stock price”
Nikkei Indexes, 2011. Nikkei Stock Average Index Guidebook. [pdf] Tokyo: Nikkei Inc. Available at:
http://indexes.nikkei.co.jp/nkave/archives/file/nikkei_stock_average_guidebook_en.pdf [Accessed 20 March 2014].
18
Same as 17
17
19
founded to envisage the industrial situation of Japan. The final decision about changes of constituents is
taken by Nikkei Inc. after consulting a committee of academics and market professionals.
If speaking about the Extraordinary Replacement revision, it is mainly intended to review the situation
incurred due to specific events that require the delisting of some stocks. It is not applied when we want to
simply add a new constituent and delete another. Company delisting comes in certain cases, such as
mergers, bankruptcy, liquidation, share transfer, share exchange, excel debt, transfer to second section,
etc. The Extraordinary Replacement is scheduled depending on these events. The procedure of replacing
delisted securities and adding new ones is generally based on selecting by liquidity and sector balance
criteria, procedure that was described above.19
Calculation method
Nikkei 225 is a price weighted index. Before calculating it, the stock price is adjusted as indicated below.
Adjusted stock price = stock price * 50 (yen) / presumed par value (yen)
Nikkei Stock Average = sum of Adjusted Stock Price / Divisor
Before the revision of the Commercial Law in 2001, Japanese stocks had par value. In spite of the
abolishment of this system, nowadays many stocks’ prices are derived from the ex-par value, most
common values being 50, 500 or 50 000 yen. What Nikkei is doing is to adjust the prices of the
constituents to a presumed par value of a 50 yen base. Even though the majority of the constituents have
a presumed par value of 50 yen, there are some exceptions. For instance, Sumitomo Mitsui Financial
Group, Inc. has a par value of 500, while Honda Motor Co., Ltd has a par value of 25.20 In case of stock
split, the par value will change (e.g. if a stock with a 50 yen presumed par value goes 1 to 2 split, the new
par value will be 25). The changing of the par value when a stock splits permits to keep the divisor intact.
Due to the changes in the constituents and stock splits, the divisor has to be periodically modified in order
to keep the continuity of the index. The adjustment of the devisor is based on the Dow method. Devisor is
reviewed in two cases: either when there are changes in the constituents and the sum of stock prices
changes, or in case of corporate actions such as split, reverse split, paid-in capital increase. However, in
case of reverse split in large scale, the devisor remains unchanged, while the presumed par value is
adjusted.
19
Nikkei Indexes, 2011. Nikkei Stock Average Index Guidebook. [pdf] Tokyo: Nikkei Inc. Available at:
http://indexes.nikkei.co.jp/nkave/archives/file/nikkei_stock_average_guidebook_en.pdf [Accessed 20 March 2014].
20
Nikkei Indexes, 2011. Nikkei Stock Average Par Value. [pdf] Tokyo: Nikkei Inc. Available at:
http://indexes.nikkei.co.jp/nkave/archives/file/nikkei_stock_average_par_value_en.pdf [Accessed 20 March 2014].
20
The devisor is calculated as:
Divisor tomorrow = Divisor today * sum of base prices for the next day constituents /
sum of “closing prices” of today’s constituents
Since 2010, Nikkei 225, whose values are displayed in Japanese yen, is calculated every 15 seconds of the
trading hours of the TSE.21
Evolution
Graph 1:
Nikkei Stock Average’s evolution since creation
(point)
Nikkei 225 evolution
50000
40000
30000
close price
20000
10000
0
1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 2014
(year)
Source: Author, based on historical annual data provided by Nikkei Indexes,
<http://indexes.nikkei.co.jp/en/nkave/archives/data>, retrieved on 20.03.2014
3.3
TOPIX
Introduction
Tokyo Stock Price Index, known as TOPIX is a Japanese index calculated by Tokyo Stock Exchange
(TSE). It comprises domestic common stocks listed on the First Section of TSE. Compared to the price
weighted Nikkei 225, TOPIX is a market capitalization index. Its calculation started on January 4, 1968
with a base point of 100.22
Constituents
TOPIX is made of around 1700 constituents. Its constituents are organized in 17 categories that classify
the 33 sectors according to the industrial sectors defined by the Securities Identification Code Committee.
Furthermore, this division permits the calculation of TOPIX sector indices and of TOPIX 17 series.23 For
a detailed sector classification see Annex D.
21
Same as 17
Indices. Tokyo Stock Exchange [online]. Available at: http://www.tse.or.jp/english/market/topix/index.html [Accessed 20
March 2014].
23
Same as 22
22
21
Constituents’ changes
Contrary to Nikkei 225, TOPIX does not need to make annual reviews of the constituents. This is due to
the fact that TOPIX comprises all domestic common stocks listed on the First Section of Tokyo Stock
Exchange, and eventual changes will occur only in case of companies’ listing or delisting on this section.24
Calculation method
Previously, TOPIX was calculated every 15 seconds through the TSE Market Information System.
However, since September 13, 2010, TOPIX calculation interval became 1 second. Contrary to Nikkei
225, TOPIX implements the free-float adjustment technique. This is taking into account when establishing
the current market value. The current market value (CMV) represents the sum of the price multiplied by
the number of free-float adjusted shares of the constituents. TOPIX is calculated according to the formula:
TOPIX = CMV/BMV * Base point
where
- CMV represents the current free-float adjusted market value
- BMV stands for the base market value
The value of TOPIX is expressed in points. The base point of TOPIX is 100. However, 9 out of those 33
sector indices that are part of TOPIX have a base point of 1000. As changes in the number of constituents
and public offerings have no connection with the stock market fluctuation, the necessary adjustments are
made to the base market value (BMV) rather that to the current market value (CMV). Among the events
that require the adjustment of base market value are: initial listing, assignment to the TSE First Section
from the TSE Second Section, delisting, reassignment from the TSE Second Section to the TSE First
Section, etc. This will maintain the continuity of the index.25
The number of shares for index calculation represents the number of listed shares for index calculation
multiplied by the free-float value. Usually, the number of listed shares for index calculation and the
number of shares issued does not differ. Nevertheless, there are cases like stock split, when these values
might not coincide. Another example of discrepancy between these two values is the case of Nippon
Telegraph and Telephone Corporation and Japan Tabacco Inc. For these two companies, the number of
outstanding shares does not coincide with the number of listed shares for index calculations because a part
of the shares are held by the government and this part is not included.26
24
TOPIX and Nikkei225. Tokyo Stock Exchange [online]. Available at:
http://www.tse.or.jp/english/market/topix/comparison.html [Accessed 20 March 2014].
25
Tokyo Stock Exchange, 2012. Tokyo Stock Exchange Index Guidebook. [pdf] Tokyo: Tokyo Stock Exchange. Available at:
http://www.tse.or.jp/english/market/topix/b7gje60000003v3u-att/b7gje60000006cm3.pdf [Accessed 20 March 2014].
26
Same as 25
22
Free-float weight (FFW) is calculated as:
FFW = 1* (1- Non FFW),
where the Non FFW represents the non-free-float shares divided by the number of listed shares. The freefloat weight is revised one a year; however in case of the occurrence of significant events TSE might
conduct an extraordinary review. A few examples of such events are: allocation of new shares to a third
party, company spin-off, conversion of preferred shares or exercise of subscription warrants, merger, stock
swap, take-over bid, etc. As a general rule, the following shares are considered by TSE not to be freefloat: “shares held by the top 10 major shareholders, treasury stocks, shares held by board members and
other shares deemed by TSE to be unavailable for trading in the market.”27
In 2004, Tokyo Stock Exchange announced its intention to apply free-float weight methodology on
TOPIX and on other TOPIX related indices. This decision was mainly directed to index funds, whose
number increased in that period. Free-float adjustment methodology benefices index funds by helping to
reduce the discrepancy between share prices’ demand and supply. Since 2006, TOPIX applies free-float
weighting. For those interested in a benchmark reflecting total market capitalization, TSE is publishing
Ex-TOPIX, which has the same features as TOPIX except the fact that it is not free-float adjusted.28
Evolution
Graph 2:
TOPIX’s evolution since creation
Source: Tokyo Stock Exchange, <http://www.tse.or.jp/english/market/topix/history/index.html>, retrieved on 20.03.2014
27
Same as 25
Tokyo Stock Exchange, 2005. TOPIX moves to Free-Float. [pdf] Tokyo: Tokyo Stock Exchange. Available at:
http://www.tse.or.jp/english/market/topix/b7gje60000003v3u-att/pamphlet-e.pdf [Accessed 20 March 2014].
28
23
3.4
Japanese indices comparison
There has always been a debate among investors all over the world on which Japanese index better reflects
Japanese economy and shall be used in different investment products. This chapter will try to compare and
evaluate the methods of construction of Nikkei 225 and TOPIX. The comparison is mainly going to be
focused on the following criteria:
1) Provider
2) Issue composition and number of constituents
3) Sector differences
4) Calculation methodology
5) Base revision
6) Unit
7) Usage
8) Costs
Before proceeding to the comparison, I would like to mention that the dividend reinvestment criterion is
not going to be regarded, as neither Nikkei 225 nor TOPIX are performance indices.
Nikkei 225 and TOPIX are nowadays calculated by two different institutions. Initially, both Nikkei 225
and TOPIX had been calculated by TSE, however since TSE began calculating TOPIX, Nikkei 225’s
calculation was taken by a daily Japanese economic newspaper. This is a good reason that explains the
popularity of Nikkei 225 over TOPIX. Grace to Nihon Keizai Shimbun, Nikkei 225 had always a better
visibility in media. These two Japanese indices are compared on financial markets with Dow Jones
Industrial Average and S&P 500. Dow Jones’s methodology of construction and popularity is very similar
to Nikkei’s. On the other hand TOPIX, which is much more complex and gives a better reflection of
Japanese economy, is often compared to S&P 500.
If speaking about the companies included in the index, TOPIX with 1700 companies is exceeding several
times Nikkei that has only 225. Both indices have in their composition companies listed on the First
Section of TSE. Judging from this fact, TOPIX is much more diversified and complete. It offers a better
Japanese market representation. However, some investors claim that the large number of constituents can
sometimes generate liquidity problems for TOPIX.29 On the other side, Nikkei 225 does not face liquidity
problems, as one of the main index inclusion criteria is the liquidity of the stock.
29
ENDO, Nobuya, 2013. Japanese benchmarks The Nikkei and the TOPIX Face-off. [pdf] State Street Global Advisors.
Available at:
http://www.ssga.com/library/povw/516936_Japanese_Benchmark_The_Nikkei_and_the_TOPIX_Face_OffCCRI1362694345.p
df [Accessed 20 February 2014].
24
Overall, there are no big differences in the sector allocation of each index. Nevertheless, there are a few
remarks to be made. As showed in table 1, the most significant weight difference is in the financial sector,
where TOPIX clearly surpasses Nikkei 225 with more than 11 %. On the other hand, the Information
Technology sector is given more weight in Nikkei 225, with an overexposure of around 4 %. As it was
mentioned above, Nikkei 225 is paying a special attention to sector balance when selecting the stocks in
the index, while TOPIX is just replicating the stocks that have met the criteria to be listed at the First
Section of TSE.
Table 1:
Sector allocation comparison
Nikkei 225
TOPIX
Nikkei 225
TOPIX
Sector
Weight (%)
Weight (%)
Number of companies
Number of companies
Consumer Discretionary
21.41
19.44
30
376
Consumer Staples
7.54
7.13
18
145
Energy
0.55
1.41
3
23
Financials
7.80
19.34
28
167
Health Care
8.74
5.99
10
76
Industrials
24.96
21.66
66
459
Information Technology
15.37
11.00
26
242
Materials
7.11
7.48
35
185
Telecommunication Services
6.16
4.09
4
4
Utilities
0.36
2.46
5
17
Total
100.00
100.00
225
1694
*As of December 31, 2012
*Note: the sector allocation data above is not identical with the sector classification of each index
Source: Author, based on data from Figure 1 of Japanese benchmarks The Nikkei and the TOPIX Face-off, State Street Global
Advisors,
<http://www.ssga.com/library/povw/516936_Japanese_Benchmark_The_Nikkei_and_the_TOPIX_Face_OffCCRI1362694345.
pdf>, retrieved on 20.03.2014
The most significant differences come in the calculation methodology of each index. We are speaking
about TOPIX, which is a value weighted index and Nikkei 225, which is one of the few price indices
remaining in the world. I consider the market capitalization weighting of TOPIX as a better weighting
method for an index. It offers a more accurate representation of the importance of each company in the
index and better reflects the overall Japanese stock market. The price weighted Nikkei 225 is too sensitive
to price deviations of the stocks. Futhermore, I see the fact that TOPIX applies free-float weighting as an
important advantage. The free-float adjusted TOPIX is allowing investors to have a better image of the
available stocks on the market.
25
The base revision is another issue where these two Japanese indices vary in methodology. In case of
Nikkei, constituents are subject to a Periodic Review and to Extraordinary Replacement reviews. Both
these reviews are selecting stocks based on their liquidity and taking into account the sector balance. The
final decision is made by a special committee of academics and market professionals. On the other hand,
TOPIX does not have any constituents’ review except the free-float weighting review, held once a year.
This is due to the fact that its components are automatically included in the index if they meet the
requirements to be listed on the First Section of TSE. In my view, the constituents’ revision of TOPIX is
more transparent than Nikkei’s. Grace to the link between TSE and TOPIX, its constituents are subject to
well-established TSE listing rules. There are no exceptions or subjective inclusions.
On the contrary, even though Nikkei 225 respects the pre-established criteria, there is place for doubts. For
instance, the fact that the sector balance is the second criterion made me think that some companies might
not be included even if they are liquid, just because Nikkei follows sector balance, or vice versa being less
liquid, but included for fitting the sector balance. Moreover, as mentioned before, Nikkei has a special
committee that decides upon the constituents’ deletion or addition, thing that makes it less objective and
transparent for the large public. This problem does not occur with TOPIX, where the TSE First Section
criteria are made for every company listed and there is no committee that can influence it. Once a
company does not fulfill the requirements, it goes to the Second Section where it is going to be a
constituent for another TSE index.
Apart from the above mentioned differences, TOPIX is calculated in points and Nikkei 225 is calculated
in Japanese yen. Point calculation of TOPIX seems much more simplistic, while Nikkei’s yen calculation
generates possible questions about the exchange rate sensitivity of the index to the Japanese currency.
Another dilemma specialists have tried to explain is the changing correlation between the Japanese yen
and Nikkei’s performance. Before the crisis, there was a negative correlation between the index and the
Japanese yen, meaning that if the yen depreciates, Nikkei will rise. However, in the last years this negative
correlation has become positive. One of the possible explanations of this correlation change is the reaction
of the Japanese economic and financial systems to the government’s efforts to solve the deflation issue.30
Both TOPIX and Nikkei are used nationally and internationally. Nevertheless, TOPIX is seen as a
“leading economic indicator” and it is widely used by Japanese government. It is also preferred by
Japanese pension funds and investment trusts grace to its complexity and transparency.31 Another reason
30
A breakdown of the Yen-Nikkei correlation? Prudent investor newsletters [online]. Available at:
http://prudentinvestornewsletters.blogspot.cz/2013/08/a-breakdown-of-yen-nikkei-correlation.html [Accessed 6 April 2014].
31
TOPIX and Nikkei225. Tokyo Stock Exchange [online]. Available at:
http://www.tse.or.jp/english/market/topix/comparison.html [Accessed 6 April 2014].
26
why long-term investors tend to choose TOPIX over Nikkei is Nikkei’s price weighting calculation,
leaving space for misrepresentation of some companies. A relevant example is Fast Retailing Co., which
was given 10 % weight in Nikkei in 2013, while only having been the 44th biggest Japanese company
according to market capitalization. Yet, Nikkei is the most traded Japanese index. This is probably due to
the international investors’ recognition and visibility in media. Some of the Nikkei’s based derivatives
such as options offer a greater liquidity than TOPIX’s options.32
Unfortunately, there is no official data about TOPIX and Nikkei’s calculation costs. We can only suppose
that TOPIX calculation costs are higher than Nikkei’s, due to the large number of constituents (1700 vs.
225). From an investor’s point of view it is less costly to perfectly track Nikkei 225 than TOPIX.
Lastly, I would like to end with the last decade’s Nikkei and TOPIX performance. From the chart below,
you can see that before the crisis, both indices had almost the same performance. However, after the crisis
the situation has changed in Nikkei’s favor, which was and is considerably outperforming TOPIX. Trying
to find an explanation, I can assume that this issue might be caused by certain sector differences. I
consider that the overexposure of TOPIX to financial sector (with over 11 % compared to Nikkei) had a
noticeable impact on TOPIX evolution. The crisis recovery of the Japanese financial sector might have
been slowing TOPIX performance.
Graph 3:
Nikkei 225’s relative performance versus TOPIX (2005-2014)
Source: Author with minor format modifications, based on data and chart draw options of bigcharts.marketwatch.com,
retrieved on 28.03.2014
32
BOUSSER, Thimothee, 2013. A closer look at TOPIX. The asset [online]. Available at:
http://mobile.theasset.com/inside.php?tid=24654 [Accessed 6 April 2014].
27
The table below summarizes the main points described above and comprises the current index values.
Table 2:
Comparison of Nikkei 225 and TOPIX Summary
Criteria
Provider
Year of creation
Base value
Issue composition
Number of constituents
Methodology
Base revision
Unit
Calculation interval
Current index value
(as of 10.04.2014)
TOPIX
Tokyo Stock Exchange Inc.
Nikkei 225
Nihon Keizai Shimbun (Nikkei Inc.)
Economic newpaper
1968
1950
100 points
176.21 yen
All companies listed on the First 225 companies listed on the First
Section of TSE
Section of TSE
Around 1700
225
Free-float adjusted
Average price weighted
Market capitalization weighted
No constituents’ review due to TSE
Periodic Review (once a year),
First Section listing rules, free-float
Extraordinary Replacement review
value review once a year
Point
Yen
1 second
15 seconds
1 149.4933
14 300.1234
Source: Author
3.5
The joint index JPX-Nikkei Index 400
There was always a debate on which Japanese index is better and more representative. Some claimed that
TOPIX comprises too many stocks, others that Nikkei is old-fashioned and less transparent. As we could
see, both indices have their pros and cons. This year has brought an interesting solution to the polemic
discussions over the superiority of those two Japanese indices. To be more precise, a new Japanese joint
index has been created. The new index is called JPX-Nikkei Index 400 and it is jointly calculated by
Nikkei Inc., Tokyo Stock Exchange and Japanese Exchange Group. It has 400 constituents selected from
the First and Second Section of TSE, as well as from the Mothers and JASDAQ markets. Currently, the
biggest part of the constituents (388 out of 400) are stocks listed on the First Section.
Index calculation started this year, on January 6, 2014, however the base date was chosen to be August 30,
2013. Its base value is 10 000 points and similarly to TOPIX, it is calculated every second of the trading
hours of TSE. JPX-Nikkei Index 400 is a market capitalization index whose stocks are free-float adjusted.
33
TSE first section issues. Google finance [online]. Available at:
https://www.google.com/finance?q=INDEXTOPIX%3ATOPIX&ei=htlGU6DvD8aDwAPFJA [Accessed 10 April 2014].
34
Nikkei 225. Google finance [online]. Available at:
https://www.google.com/finance?q=INDEXNIKKEI%3ANI225&ei=i9lGU5DELcGkwAOOxgE [Accessed 10 April 2014].
28
The components are revised once a year during the Annual Review held in August. The stocks are
selected based on the last three years trading volume and market value. Moreover, it takes into account
things like the three-year ROE and cumulative operation profits. Lastly, stocks are ranked based on
qualitative factors such as corporate governance.35
This index represents a real combination of features between TOPIX and Nikkei. It comprises an optimal
number of constituents, being somehow between those two giants. It is calculated after the same
methodology of TOPIX but it has more intricate selection criteria, thing that makes it resemble to Nikkei.
Last but not least, as this index is a joint project between Japanese Exchange Group, TSE, and Nikkei Inc.,
we can expect a higher visibility in media grace to Nikkei’s implication.
35
Tokyo Stock Exchange, 2014. JPX-Nikkei Index 400 Factsheet. [pdf] Tokyo: Tokyo Stock Exchange. Available at:
http://www.tse.or.jp/english/market/topix/b7gje6000001ns00-att/b7gje6000001rsua.pdf [Accessed 6 April 2014].
29
Chapter 4
4.1
Index investing
Index investing – active vs. passive
It seems that the famous and perpetual debate between adepts of active and passive investment strategies
will never reach a trade-off. Active management is based on the principle that the price of some stocks
available on the market does not reflect their intrisic value. Active managers are actively searching for
stocks that are underpriced to include them in their portfolios. Therefore, if indeed a stock is undervalued,
the manager will gain a better return than the benchmark. In order to identify the mispriced stoks, an
ample research is required. On the other hand, passive management regards the price of the stocks as
being fair and does not see any major discrepancy between stocks’ intrisic value and their price. Passive
investment strategy is not intending to outperform the market. It chooses passive strategies (e.g. index
funds) that would provide returns as those of the benchmark’s.36
Active managers are persuaded that it is possible to beat the market giving the example of Warren
Buffett’s success. Passive investors, rather than trying to beat the market, are satisfied with reaching
average market returns. It is right that active investing and active funds have a much longer history than
the passive investing who has appeared only in 1970s. When choosing among these two strategies, active
investing in given preference. Most people still think that the active managers they choose are talented and
able to beat the market in exchange to the high fees charged. However, data proves the contrary and even
if it is possible to reach greater returns with active investing, the fees paid to managers can reduce them.
For instance, if an index fund charges an annual fee of 0.2 percent, an active fund is charging 1.2 percent.
With the birth of passive investing and a wide range of indices all over the world, large public was
provided an alternative. They can now choose between the low-costs index funds and exchange-traded
funds (ETFs).37
There is a well-established prejudice that passive investing is a boring investment approach. Index
investing and index-based products as part of passive investing are also regarded to be tedious. As a
reaction to this malconcept, a series of arguments has been developed showing that indexing can be active
as well.
36
ARNOTT D., Robert; HSU C., Jason; WEST M., John. The fundamental index: a better way to invest. Hoboken, New Jersey:
John Wiley and Sons, Inc., 2008. 311 p. ISBN 978-0-470-27784-3, pp. 44-46.
37
FERRI A., Richard. The power of passive investing: more wealth with less work. Hoboken, New Jersey: John Wiley and
Sons, Inc., 2011. 264 p. ISBN 978-0-470-59220-5, pp. 3-14.
30
The first argument of the active index concept is that index construction and selection is active. Active
decision making is required when selecting the securities that are going to be part of an index, when
giving them the proper weight and when the index is being periodically rebalanced. Moreover, due to the
expansion of index-based products, investors are constantly put in the situation to make decisions
connected to those products or the choice of the benchmark.
Surprisingly for the large public, but managing index-based portfolios is also an active process. It
implies a big dose of effort and competence to carry out a deep market microstructure analysis. Lastly, it
is said that the use of index products is also active. Choosing among a wide variety of index-based
products is as active as an investor wants it to be. It is particularly active to determine which index
products to include in the portfolio and in what proportion.
The debate active versus passive is useless. No one tries to say that we have to choose only one strategy
and apply it. On the contrary, it is advisable to combine these two options. This combination is an efficient
way to maximize the performance of the portfolio while minimizing the risk. Indexing should not be
regarded only as a subsitute, but rather as a appropriate tool to increase the efficiency of the portfolio.38
4.2
Factors contributing to the growth of indexing
Indexing is an investment option that has gained popularity in the last decades. Even though in the 1970s
indexing was seriously regarded only by academics, ten years later the situation has changed. Institutional
investors began switching their attention to index investment opportunities. There have been four major
factors that led to the growth of indexing, that are actually representing four great advantages of this
investment strategy. These factors are:
a) Ease in risk budgeting
Risk is a key criterion for every investor. Besides considering the risk of an investment portfolio, an
investor is also caring about the relative risk that his portfolio returns will deviate from a certain
benchmark. An investor can choose to either replicate the benchmark or to invest in other shares except
those comprised in it. In case he chooses the second strategy, his returns might deviate from benchmark’s
returns. What index managers do is to copy the index, this being the only way to exclude the relative risk.
38
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, pp. 2-4.
31
b) Lower fees and costs
Compared to the fees paid to an active manager, generally the fees charged by index managers are lower.
If speaking about the costs, both active and passive managers have expenses, however, they are a bit
different. The research costs of active managers are much higher, as they continuosly seek for a better
investment, while index managers’ research costs are relatively lower. Moreover, due to his changing
investment choices, an active manager meets higher turnover-related costs, while an index manager
supports only the costs of portfolio adaptation related to index changes. Lastly, as mentioned before,
indexing gives an incredibly valuable base to crossing opportunities. While active managers do not have
access to crossing networks, index managers do have and by using them they save a big amount of
transaction-related costs.
c) Relative ease in choosing managers
While choosing an active manager implies a more intricate selection procedure, the choice of an index
manager is considered to be easier. First of all, because his main task is to replicate the benchmark.
Second, because the benchmark offers an ideal criterion to evaluate his performance.
d) Competitive performance against active managers
History gives evidence that in both short and long-term investment strategy, benchmark’s returns are
either close or above the returns of active managers.39
4.3
Index investment opportunities
The 1970s represented a milestone in index investing. The first index fund launched in 1971 by Wells
Fargo Bank and the first retail index fund lauched by Vanguard a few years later in 1976 gave the start of
a new era in index industry. The 1980s not only brought some innovative products such as stock index
futures and options, but also held the expansion of index funds. The next decade was fundamental in the
development of index-based investment. The bull market of the 1990s was a perfect premise to strenghten
the position of index funds and to increase their usage in Japan and Europe. This was also the time when
the first Exchange-traded funds (ETFs) were introduced in the United States and Canada. ETFs became so
popular that in the first four years of the twenty first century there occurred a global ETF explosion.
Beside this ETF interest increase, the period between 2000 and 2004 brought a new technique considered
to be the most important index change ever. We are speaking about the float adjustment, implemented by
major global and local indices.40
39
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, pp. 32-37.
40
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, pp. 11-13.
32
There are several index-based investment vehicles, the most important being:
a) Index funds
b) Index certificates
c) Index products
4.3.1
-
Exchange-Traded funds (ETFs)
-
Index based derivatives
Index funds
An index fund is an investment fund whose strategy is to replicate the performance of an index. That is
why index funds invest in assets which are included in a chosen reference index. Contrary to active
investment funds, who will always try to beat the market, index funds do not aim at outperforming the
benchmark.41
The four main advantages of index funds are:
a) Liquidity and capacity
The majority of index funds use indices that include large capitalization stocks. Grace to the fact
that these stocks are large-cap, they are popular among investors, making them extremely liquid.
This liquidity results in a big trading volume. Moreover, index funds have a huge capacity due to
their investment in indices that track thousands of securities on the market. You may argue that
active managers may also investing in liquid, large-caps stocks. However, their problem is that
they focus on undervalued stocks only, thus being limited to fewer titles in their portfolio.
b) Built-in diversification
As indices were primarily designed to represent the whole market, it is clear that by their nature
they offer a broader diversification. Having a large number of stocks included, indices like S&P
500 or Russell 1000 reflect a wide range of economic sectors and industries.
c) Low turnover, low taxes
Index funds through their passive strategy register a much lower turnover than active managers.
Futhermore, this low turnover is an extremely valuable benefit when time comes to pay taxes. This
thing occurs because index funds invest in indices, and indices generally does not show a high
turnover. Usually, turnovers in indices are generated when a stock suffers some changes as a
merger, acquisition or bankrupcy and it does not fullfill index criteria anymore. On the other hand,
active investment implies constantly buying and selling stocks on the under/over valued principle,
resulting in a high turnover. Besides, the capital gains and dividends which are subject to taxation
make them less attractive compared to index funds.
41
SVOBODA, Martin. Indexové investice. Brno: Dimension a.s., 2001. 274 p. ISBN 80-238-7634-1, p. 54.
33
d) Ease in implementation and monitoring
Index funds offer an easy way to follow the performance of their managers. The activity of index
fund managers is also similar, as they all have the same portfolio strategy. Futhermore, issues like
style drift, conflict-of-interest or discretion in decision making will not appear.42
The table below summarizes the main differences between the active investing strategy and index fund
investing.
Table 3:
The difference between Active and Index Fund investment strategies
Subject
Return objective
Active Investing
Beat a market
Style definition
Average equity individual
investor returns over 20 years
Approach
40% drift from classification
3.70% per year according to Dalbar for 20
year period ending 2004
Stock picking, Time picking, Manager
picking or Style drifting
Stressed
High (20-40% of returns over 10 years)
Turnover averaged 112% in 2004
Well below the index by the amount of fees,
expenses, taxes and missed opportunities
Currently about 85% of equity funds
State of mind
Taxes and portfolio turnover
Net performance
Individual investors
Institutional investors
Proponents
Currently about 56% of domestic stocks
assets
Virtually all Brockerage Firms, Mutual Fund
Companies, Market Timing Services,
Investment Press and Brockerage Training
programs
Index Fund Investing
Obtain the return of the market, index or
asset class
Pure and consistent classification
S&P 500 = 13.20% annualized
Index portfolio 100 = 15.32% annualized
Buy and hold a globally diversified
portfolio of index funds
Relaxed
Low (less than 8% of return over 10 years)
Turnover averages 10%
The index return, less low fees, low taxes
and tracking error
Currently about 15% and browing rapidly
since 1999
Currently about 44% and growing
The Univ. of Chicago, Nobel Prize
Recipients, Vanguard Group, Dimentional
Fund Advisors, Barclays Global Investors,
Warren Buffet, and Charles Schwab &
Company
Analytical techniques
Art - Qualitative, Disregard for Risk,
Science – Quantitative, Risk Management,
Forecasting, Predicting the Future, Feelings,
Long-term Statistical Analysis, Accurate
Intuition, Luck, Betting, Gambling,
Performance Measurements, (like
Speculation
Insurance Companies)
Source: HEBNER T., Mark. Index Funds: The 12-Step Recovery Program for Active Investors. Irvin, California: IFA
Publishing, Inc., 2007. 394 p. ISBN 0-9768023-0-9, p. 6.
Looking from another angle, index funds have also some disadvantages to consider. For example, if you
buy an index fund from a brockerage, you will be charged a considerable commission. You can avoid this
commission if you use your own brockerage firm. Secondly, it is highly recommendable if you invest in
an index fund not to trade it too often, but rather buy and hold, as index trading is costly. Thirdly, advisors
claim that investing in a stock index is not a replacement for a genuine asset allocation strategy. In order
42
ARNOTT D., Robert; HSU C., Jason; WEST M., John. The fundamental index: a better way to invest. Hoboken, New Jersey:
John Wiley and Sons, Inc., 2008. 311 p. ISBN 978-0-470-27784-3, pp. 49-54.
34
to reach a representative, diversified portfolio you may need various index funds that reflect different
sectors, countries or asset classes (e.g. commodities, real estate).43
4.3.2
Index certificates
Index certificates have been firstly introduced on the investment market in 1990. Despite their short
history, index certificates are widely used among investors. This product allows investors to buy a whole
stock index through a unique security. The certificate value can either fully correspond with the value of
the index, or be expressed as part of the index, for instance 1/10, 1/100 or 1/1000. Generally, an index
certificate has a fixed maturity date. When it has reached the maturity date, the certificate is paid
according to the performance of the underlying index.
The main advantages of possesing index certificates are:
a) Transparency – grace to their simple, easy-to-follow construction, index certificates are easily
comprehensible by the large public. The certificate holder can always understand the value of his
certificate by following index performance news, largely available in media.
b) Continuous trading – these certificates can be traded continuously whenever the stock market is
open. After its closing, certificates can be traded over-the-counter online.
c) Affordability – index certificates are affordable instruments. It is considerably less costly to buy
an index certificate than to create a portfolio comprising all the shares of the same index.
d) Low transaction costs – the management fees charged on maturity are not elevated. Moreover,
there are cases when index certificates’ management fees are equal to bonds’ management fees
(for certificates traded in Germany, whose ISIN begins with 1, 2, 3, and whose charged fees are
0.5 % instead of 1 %).
e) Diversification – index certificates offer a broad diversification, as an index might, for instance,
contain hundreds of different stocks.
f) Liquidity – index certificates are very liquid products. An investor can always buy or sell index
certificates as their price is continuously quoted.
Despite the multitude of advantages, there are several risks connected to index certificates. First of all,
because the price of the certificate is based on the evolution of the index, there is always the risk that, once
an index is not going to give the expected positive results, the price of the certificate will decrease. The
evolution of the index is highly correlated to the economic environment. Crucial to mention is the
currency risk. Owning a certificate issued in a foreign currency, an investor is exposed to deviations in his
43
TUCHMAN, Mitch, 2013. What is an index fund? Investing basics. Forbes [online]. Available at:
http://www.forbes.com/sites/mitchelltuchman/2013/07/12/what-is-an-index-fund-investing-basics/ [Accessed 28 February
2014].
35
profits due to possible currency changes. However, grace to Quanto certificates, which are certificates
insured against exchange rate deviation, this problem vanishes.
Another thing that can influence the change in price of a certificate is the rating of the issuer. The rating
downgrade has an immediate impact on liquidity, thus making the certificate less attractive and valuable.
The issuer itself is also representing a risk, as it can encount financial difficulties that may not allow him
to meet his obligations. There is also a spread risk, which underlines the differences in the ask and bid
price of a certificate. An investor is also exposed to the mispricing risk, when the ask price is higher or the
bid price is lower. An important risk to take in account is the maturity risk. The value of the certificate is
going to be paid to its holder on the established maturity date, not in the day a certificate reaches a
desirable price. Last but not least, there are certain subtle risks concerning taxation and legislation.44
In the final part of this subchapter, I would like to briefly mention about the costs of buying, holding and
selling of index certificates. The table below summarizes the main points.
Table 4:
Index certificates’ costs
Situation
Buying costs
Holding costs
Selling before maturity costs
Maturity costs
Costs
- Spread
- Bank comission
- Brokers commission
- For certain certificates, the issuer charges annual management fees
(1-2 %)
- Spread
- Bank comission
- Brokers commission
- Sometimes, the issuer charges fixed fees (e.g. 10 Euro)
Source: Author, based Graph 17 from SVOBODA, Martin. Indexové investice. Brno: Dimension a.s., 2001. 274 p. ISBN 80238-7634-1, p.92.
4.3.3
4.3.3.1
Index products
Exchange-traded funds
Exchange-traded funds or ETFs are funds designed to track indices, but are traded like stocks. Their aim is
not to outperform the market, but to replicate it as close as possible. Buying shares of an ETF means
buying a basket of shares included in the index that are traded as a single stock. These stocks can be
bought and sold throughout the day, thus giving ETFs an incredible good liquidity. Moreover, due to the
fact that they are based on an index, they offer a wide diversification for investors. As ETFs imply the
attractive concept of trading a basket of shares, their trading volume is bigger compared to the trading
44
SVOBODA, Martin. Indevové investice. Brno: Dimension a.s., 2001. 274 p. ISBN 80-238-7634-1, p.65-90.
36
volume of individual shares. ETF shares can be short selled, bought on margin or held for a longer
period.45
Exchange-traded funds are one of the index products that has been very popular both among individual
and institutional investors. Since their introduction in 1992/1993 in the United States, ETF market has
been growing worldwide. The reasons why investors prefer ETFs are the low costs and tax efficiency.
These advantages stem from ETFs passive strategy which does not try to beat the market. Besides,
investors like ETFs resemblance to stocks that they are accustomed with and know how to trade and
monitor them.46 Graph 4 proves both the world increase of the ETFs number as well as the augmentation
of the assets under management.
Graph 4:
Worldwide ETF Growth
* As of March 2013
Source: Deutsche Bank AG, <http://www.etf.db.com/ZAF/ENG/ETF-Knowledge/Growth-of-ETF-market>, retrieved on
28.02.2014
4.3.3.2
Index derivatives
In spite of having their origins in the United States, index based derivatives are nowadays used all over the
world. They have become a good, liquid and efficient tool for investors. Index futures, index swaps and
index options are some examples of index-based derivatives. The first index futures appeared in 1982 the
United States, where Kansas City Board of Trade offered futures contracts on their index (called Value
45
What are ETFs. Nasdaq [online]. Available at: http://www.nasdaq.com/investing/etfs/what-are-ETFs.aspx [Accessed 21
February 2014].
46
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, pp. 41-42 and p. 515.
37
Line Index). Stock index options have also seen the light in 1980s, being actively traded on various stock
exchanges in the United States.47
Index futures
Index futures are simply described as futures contracts on a stock index. Futures contracts are traded daily
on stock exchanges, thing that makes them deeply liquid. This contributes to the reduction of transaction
costs for entry and exit. The most liquid equity futures contracts in the world are the S&P 500 futures.
Generally, the interest in futures enhance in uncertain times, such as geopolitical or economic events,
when investors try to reduce their market exposure.48
Index swaps
An equity index swap is a „contract between two counter parties to exchange an interest payment for the
return of an index at some future date“.49 The dealer (financial institution) who sells the swap pays to the
customer (tipically institutional investor) the index return. The customer instead pays the dealer an interest
rate. Usually this interest rate equals the yields of the annualized London Interbank Offered Rate (LIBOR)
with a plus/minus spread added. Swaps are not traded on a stock exchange. That makes them less liquid
compared to other exchange traded vehicles.50
Index options
There are two types of index options: „a call, which gives the right to buy an index; and a put, which
gives the right to sell an index“.51 They have an expiration date, where an option can be exercised and an
exercise price. Index options can be either listed on a stock exchange or sold over-the-counter (OTC
options). These two trading possibilities make index options more liquid than for instance futures, which
are not traded OTC, or swaps which are not traded on a stock exchange. Another interesting feature of
index options similar to index swaps is their high anonimity when traded OTC.52
47
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, p. 267.
48
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, p. 510.
49
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, p. 522.
50
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, pp. 522-523.
51
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, p. 523.
52
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, pp. 523-527.
38
4.3.3.3
Choosing among index products
Several factors influence the decision of an investor who chooses among index products. Investment
strategy, time horizon, taxes, limitations and required authorizations, anonimity, transaction costs are just
few of them. For example, if the investment horizon is medium to short, it is recommendable to use
futures instead of ETFs. Futures contracts are more liquid and the comissions charged are lower. A quite
delicate factor is the specific requirements and legal authorization to buy a certain index product or to
enter a market. For instance, both ETFs and futures contracts provide investors the opportunity to access
restricted markets where direct stock investment is limited.
In spite of the fact that all the products described a few paragraphs above are index products, not all of
them can be used on whatever index. Futures are available on a small number of indices, the majority of
them being in the United States. ETFs are less limited than futures, but still not all indices can be used.
Contrariwise, swaps and OTC options are given the freedom to choose whatever index as underlying.
If talking about a sensitive criteria as the anonimity of an investor, we have seen that index futures, ETFs
and listed index options do not meet it due to the fact that they are traded on the exchange where there are
certain requirements. On the other part, index swaps and OTC index options offer a high degree of
confidentiality to investors. Anonimity is not necessarily the best option, as the price of the products that
are not publicly traded is not always available and comparable and investors might face problems because
of lack of information.53
The variety of index products available on the market gives investors enough products to choose from. It
is a matter of interests and possibilities that helps in deciding. The table below presents a full comparison
of features between the index products previously described.
53
SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through global
index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, pp. 529-533.
39
Table 5:
Comparison of features of Index Products
Futures
ETFs
Swaps
Options
About 20 in the United
States; much fewer in
non-U.S. markets
Any index
About 15 for listed ;
any for OTC
Greater than stocks
Limited
More than 100 in the
United States; more
than futures in the nonU.S. markets
Equal to stocks
Limited
Greater than stocks
High
Greater than stocks
Limited for listed; high
for OTC
Tipically same as for
stocks; some fund
limits
No
Limited to eligible
contract participants
Accredited investor for
OTC
Daily mark-to-market
CFTC registration or
„no action“ for nonU.S. products
Yes
No
Limited to selling
uncovered options
Transaction costs
Entry/exit costs
Lower than stocks
Lower or equal to
stocks
Management fee
Lower or equal to
stocks
Funding rate
Higher than stocks
Higher than or equal to
stocks
Yes
Lower than stocks
Lower than stocks
Yes
No uptick, borrow-like
stock
No minimum
Depends on underlyer
Limited for listed; high
for OTC
n/a
Varies
No minimum
Flexibility
Underlying indexes
Leverage
Anonimity
Ease of use
Regulatory
requirements
Holding costs
Interest rates
embedded in nearby
contract price +
calendar spread price
Trading efficiency
Liquidity
Higher than stocks
Capital commitement
Limited
Shorting
No uptick, no borrow
Minimum size
Tracking
Sources of
performance difference
About $25,000 and up
Option time decay may
need to roll into next
contract
Nearby mispricing +
Premium/discount to
None
Based on strike and
calendar spread
NA or market maker
term of option
mispricing
spread
Dividends
Forecasts included in
Paid quaterly
Included in capital
Forecasts included in
price
returns
price
Source: SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing risk through
global index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN 0-471-25707-9, pp. 530-531.
4.4
Nikkei 225 and TOPIX investing
Grace to its popularity, Nikkei 225 is the Japanese index that is most commonly used in international
investment products. This does not mean that there are no products on TOPIX, however, I have to admit,
that while searching for investments products, I found many more investment opportunities on Nikkei than
on TOPIX. For instance, from Picture 1 and Table 6 we can deduce that Nikkei investment products are
not only traded in Japan, but also overseas. On the other hand, TSE does not provide any official
information about the licensed exchanges and ETF providers of TOPIX. What I could find on TSE
40
website are TOPIX listed ETFs at the moment, provided by Daiwa Asset Management, Nomura Asset
Management, Nikko Asset Management and Mitsubishi UFJ Asset Management.54 Not only Japanese, but
also European financial institutions have ETFs on TOPIX. For example, Commerzbank AG manages one
of them, called ComStage TOPIX UCITS ETF.55
Table 6:
Nikkei Licenced Exchanges and ETF Providers
Exchanges
ETF Providers
Singapore Exchange Limited
Osaka Securities Exchange
CME Group
Tokyo Stock Exchange
Tokyo Financial Exchange
Nomura Asset Management
Daiwa Asset Management
Nikko Asset Management
BlackRock
Commerzbank
Mitsubishi UFJ Asset Management
Credit Suisse
Simplex Asset Management
Precidian Investments
Deutsche Bank
Source: Author, based on data provided by Nikkei Indexes, <http://indexes.nikkei.co.jp/en/nkave/info>, retrieved on 06.04.2014
Picture 1:
Nikkei Licencees
Source: Nikkei Indexes, <http://indexes.nikkei.co.jp/en/nkave/info>, retrieved on 06.04.2014
54
Listed ETFs. Tokyo Stock Exchange [online]. Available at: http://www.tse.or.jp/english/rules/etfs/list/ [Accessed 9 April
2014].
55
Global ETFs/Commerzbank AG. Trustnet offshore [online]. Available at: http:
http://www.trustnetoffshore.com/Factsheets/Factsheet.aspx?fundCode=HZFV9&univ=E [Accessed 9 April 2014].
41
4.5
Index investing comparison
For the practical part of this chapter, I have decided to focus my attention on Index Certificates and ETFs
that have as underlying Nikkei 225 and TOPIX. I have selected for each index two certificates. These
certificates are issued by two European banks, Deutsche Bank AG and Commerzbank AG.
Index Certificates
Table 7:
Nikkei and TOPIX certificate comparison
Certificate name/
criteria
Unlimited Index
Nikkei 225 X-pert TOPIX Index
Certificate
X-pert Certificate Certificate on
Nikkei 225
Issuer name
Product type
Deutsche Bank
AG
X-pert Certificates
Deutsche Bank
AG
X-pert Certificates
Maturity
Open End
Current price*
Bid/Ask (EUR)
Quanto
Ratio
Issue date
Performance 1 year
Management fees
VaR56
(EUR, 250 days)
Unlimited Index
Certificate on
TOPIX
Commerzbank AG
Commerzbank AG
Open End
Unlimited Index
Certificate
Open End
Unlimited Index
Certificate
Open End
10.420/ 10.430
No
0.10
13/02/2001
0.29 %
none
8.410/ 8.430
14.71/ 14.74
11.89/ 11.91
No
1.00
13/02/2001
-2.77 %
none
Yes
1000:1
18/09/2000
unavailable
none
Yes
100:1
18/09/2000
unavailable
none
4070.59
3787.26
4158.22
3906.01
* As of April 7, 2014
Source: Author, based on data provided by Deutsche Bank AG and Commerzbank,
<https://www.xmarkets.db.com/DE/ENG/Product_Detail/DE0007093387>,
<https://www.xmarkets.db.com/DE/ENG/Product_Detail/DE0007093379>,
<http://www2.warrants.commerzbank.com/Products/ProductDetails.aspx?rp=None&rps=None&c=1077594&p=139666724&
pc=81&dm=NoHeaders&ip=1&pm=Full>,
<http://www2.warrants.commerzbank.com/Products/ProductDetails.aspx?rp=None&rps=None&c=1077594&p=139666716&
pc=81&dm=NoHeaders&ip=1&pm=Full>, retrieved on 07.04.2014
Deutsche Bank offers Nikkei 225 and TOPIX X-pert certificates that do not have a fixed maturity date.
They were issued the same day and they are not insured against currency risk. As seen from the table
above, TOPIX certificates are cheaper and their Value at Risk is lower, appearing at first sight more
attractive. However, their negative performance of -2.77 % during last year compared to the positive
performance of those of his rival makes me recommend Nikkei 225 X-pert Certificate.
56
The VaR (Value at Risk) is the loss of an investment of 10.000 EUR in this certificate which will not be exceeded with 99
percent probability during the given period of time.
42
Another option that has been viewed is the Quanto certificates on Nikkei and TOPIX, issued by
Commerzbank. We can notice the same tendency of a higher price of Nikkei compared to TOPIX
certificates. Similarly to Deutsche Bank Certificates, the Value of Risk is also working in favor of TOPIX.
However, despite the absence of data on one year performance, there is an important remark to be made. If
you look on Commerzbank website at the performance of these certificates, you can notice that before the
crisis, both certificates were traded at almost the same prices (between 16-18 EUR). However, after the
crisis, Nikkei certificate has managed to recover far better than TOPIX certificate. An eloquent proof of
the post-crisis performance is the actual price of Nikkei certificate. Looking some chapters back, we have
seen and commented on the over-performance of Nikkei compared to TOPIX since 2009. As certificates
track indices, this result on the price and evolution of index certificates has been expected. Concluding,
between Commerzbank’s Quanto certificates, I think the certificate on Nikkei is a better choice.
ETFs
For the second part of this subchapter, ETF investment is going to be analyzed. For a fair comparison, I
have chosen for each index an ETF that is provided by the same management company called Nomura
Asset Management Co., Ltd.
Table 8:
Nikkei and TOPIX Exchange-Traded Funds comparison
Fund name
Underlying index
Management company
Dividend payment date
Trading unit
Total expense ratio
- With in tax
ETF net assets
Shares outstanding
Market price
Gross dividend paid
12 months dividend yield
Investment amount per lot
Return on investment
(past 1 year)
Return on investment
(past 5 years)
Volatility (90D)
Nikkei 225 Exchange-Traded Fund
Nikkei 225
Nomura Asset Management
8 July of each year
1 unit
0.24 %
0.252 %
1 854 395 (mil JPY)
122 465 thous.units
15 150 JPY
187 JPY
1.23 %
15 150 JPY
TOPIX Exchange-Traded fund
TOPIX
Nomura Asset Management
10 July of each year
10 units
0.11 %
0.1155 %
1 517 679 (mil JPY)
1 227 667 thous.units
1 234 JPY
19.4 JPY
1.57 %
12 340 JPY
+ 33.63 %
+ 26.56 %
+ 112.48 %
23.3 %
+ 76.03 %
20.9 %
Source: Author, based on data provided by Tokyo Stock Exchange Nikkei and TOPIX ETF pamphlets,
<http://www.tse.or.jp/english/rules/etfs/list/pamphlet/1306-e.pdf>, <http://www.tse.or.jp/english/rules/etfs/list/pamphlet/1321e.pdf>, retrieved on 07.04.2014
43
After studying the updated prospectus of each ETF, I have noticed that except the underlying index, there
are no differences in the investment policy, investment restrictions, distribution policy, risk management
system or tax treatment. Major differences between Nikkei 225 Exchange-Traded Fund and TOPIX
Exchange-Traded Fund are summarized in the table above.
TOPIX ETF is the largest ETF in Japan.57 As you can see, there are some differences in the trading unit,
Nikkei having trading unit one, while TOPIX ten. This thing is also reflected in the market price of the
ETF, as the market price of Nikkei is more than twelve times higher than TOPIX’s. However, if you look
at the investment amount per lot, you will see where the balance comes between these two ETFs.
Personally, I regard TOPIX’s the smaller investment amount per lot as an advantage, which gives the
general investment public a cheaper way to buy ETFs. I would recommend an investor to rather invest in
TOPIX ETFs than in Nikkei’s. It is true that Nikkei 225 ETF generates better returns on investment than
TOPIX, but there are several disadvantages that work in TOPIX’s favor. First of all, Nikkei’s ETF total
expense ratio which either with or without tax, is more than twice higher than TOPIX’s. Second, the
dividend yield is slightly better in case of TOPIX. Thirdly, TOPIX’s volatility is a few percent less than
Nikkei’s ETF volatility.
57
TOPIX and Nikkei225. Tokyo Stock Exchange [online]. Available at:
http://www.tse.or.jp/english/market/topix/comparison.html [Accessed 6 April 2014].
44
Conclusion
Stock indices represent a primordial instrument for financial markets. In this thesis we have seen that
during the last century the world of indices has considerably evolved. Nowadays, indices are not only used
to describe the situation on the stock market, but also serve as a basis for a multitude of investment
products. We have also seen that there are several possibilities to build an index and give weight to its
components. There have been underlined special adjustment techniques and the free-float methodology.
Furthermore, this thesis is not limited to index construction only, but also has tried to show one of the
practical aspects of index usage. Hence, the last chapter was aimed at index investing where you could
also see why index investing became so popular in a short time. Even though index investing is considered
to be part of passive investment strategy, it has been proved that it can be considered active as well.
Lastly, the thesis incorporated a short description and comparison of index investment opportunities.
For the practical side, two Japanese rivals have been described, TOPIX and Nikkei 225. We have seen
how different their construction methodology is. My opinion is that among these two indices, TOPIX’s
way of construction is better. I think that a value weighted index is more representative than a price
weighted index. Besides, the free-float weight technique implemented by TOPIX is a modern tool that
improves index calculation and is useful for potential investors and index funds. Moreover, I definitively
see constituents’ selection at TOPIX as a much more transparent process than in case of Nikkei 225.
Finally, I think that grace to its larger number of constituents TOPIX is much better diversified and has a
bigger capacity to reflect Japanese economy.
Except the index construction aspect, this thesis was analyzing possible investment products related to
Nikkei 225 and TOPIX. You could see a comparison between TOPIX and Nikkei 225 index certificates as
well as these indices’ two ETFs. After comparing these investment opportunities, I am not categorical
about one single index. This comparison has proven that in some cases Nikkei’s products can generate
better returns than TOPIX’s and vice versa.
The goal of this thesis was to analyze the chosen Japanese indices of financial and capital markets, to
evaluate methods of their construction and formulate recommendations. I consider this goal accomplished
because both Nikkei 225 and TOPIX methods of construction were described in details and given an
evaluation. Furthermore, there has been provided a comparison of index investment products on these
indices and have been given conclusive opinions about which investment product to choose.
45
References
Specialized literature:
[1] ARNOTT D., Robert; HSU C., Jason; WEST M., John. The fundamental index: a better way to invest.
Hoboken, New Jersey: John Wiley and Sons, Inc., 2008. 311 p. ISBN 978-0-470-27784-3.
[2] FERRI A., Richard. The power of passive investing: more wealth with less work. Hoboken, New
Jersey: John Wiley and Sons, Inc., 2011. 264 p. ISBN 978-0-470-59220-5.
[3] HEBNER T., Mark. Index Funds: The 12-Step Recovery Program for Active Investors. Irvin,
California: IFA Publishing, Inc., 2007. 394 p. ISBN 0-9768023-0-9.
[4] SCHOENFELD A., Steven. Active Index investing, maximizing portfolio performance and minimizing
risk through global index strategies. Hoboken, New Jersey: John Wiley and Sons, Inc., 2004. 688 p. ISBN
0-471-25707-9.
[5] SVOBODA, Martin. Indexové investice. Brno: Dimension a.s., 2001. 274 p. ISBN 80-238-7634-1.
[6] VESELA, Jitka. Investování na kapitálových trzích. Prague: ASPI, 2007. 704 p. ISBN 978-80-7357297-6.
Internet sources:
[7] A breakdown of the Yen-Nikkei correlation? Prudent investor newsletters [online]. Available at:
http://prudentinvestornewsletters.blogspot.cz/2013/08/a-breakdown-of-yen-nikkei-correlation.html
[Accessed 6 April 2014].
[8] Big charts market watch [online]. Available at: http://bigcharts.marketwatch.com/ [Accessed 28 March
2014].
[9] BOUSSER, Thimothee, 2013. A closer look at TOPIX. The asset [online]. Available at:
http://mobile.theasset.com/inside.php?tid=24654 [Accessed 6 April 2014].
[10] ENDO, Nobuya, 2013. Japanese benchmarks The Nikkei and the TOPIX Face-off. [pdf] State Street
Global Advisors. Available at:
http://www.ssga.com/library/povw/516936_Japanese_Benchmark_The_Nikkei_and_the_TOPIX_Face_Of
fCCRI1362694345.pdf [Accessed 20 February 2014].
[11] Global ETFs/Commerzbank AG. Trustnet offshore [online]. Available at: http:
http://www.trustnetoffshore.com/Factsheets/Factsheet.aspx?fundCode=HZFV9&univ=E [Accessed 9
April 2014].
[12] Growth of ETF market. Deutsche Bank AG [online]. Available at:
http://www.etf.db.com/ZAF/ENG/ETF-Knowledge/Growth-of-ETF-market [Accessed 28 February 2014].
[13] Historical data. Nikkei Indexes [online]. Available at:
http://indexes.nikkei.co.jp/en/nkave/archives/data [Accessed 20 March 2014].
46
[14] History of TOPIX. Tokyo Stock Exchange [online]. Available at:
http://www.tse.or.jp/english/market/topix/history/index.html [Accessed 20 March 2014].
[15] Indices. Tokyo Stock Exchange [online]. Available at:
http://www.tse.or.jp/english/market/topix/index.html [Accessed 30 March 2014].
[16] Information. Nikkei Indexes [online]. Available at: http://indexes.nikkei.co.jp/en/nkave/info
[Accessed 6 April 2014].
[17] KENNEDY, Mark, 2014. Different types of weighted indexes. Exchange traded funds [online].
Available at: http://etf.about.com/od/etfbasics/a/Different-Types-Of-Weighted-Indexes.htm [Accessed 22
February 2014].
[18] Listed ETFs. Tokyo Stock Exchange [online]. Available at: http://www.tse.or.jp/english/rules/etfs/list/
[Accessed 9 April 2014].
[19] Nikkei 225. Google finance [online]. Available at:
https://www.google.com/finance?q=INDEXNIKKEI%3ANI225&ei=i9lGU5DELcGkwAOOxgE
[Accessed 10 April 2014].
[20] Nikkei Indexes. Nikkei Indexes [online]. Available at: http://indexes.nikkei.co.jp/en/nkave/index
[Accessed 30 March 2014].
[21] Nikkei Indexes, 2011. Nikkei Stock Average Index Guidebook. [pdf] Tokyo: Nikkei Inc. Available at:
http://indexes.nikkei.co.jp/nkave/archives/file/nikkei_stock_average_guidebook_en.pdf [Accessed 20
March 2014].
[22] Nikkei Indexes, 2011. Nikkei Stock Average Par Value. [pdf] Tokyo: Nikkei Inc. Available at:
http://indexes.nikkei.co.jp/nkave/archives/file/nikkei_stock_average_par_value_en.pdf [Accessed 20
March 2014].
[23] Nikkei 225 X-pert Certificate. Deutsche Bank AG [online]. Available at:
https://www.xmarkets.db.com/DE/ENG/Product_Detail/DE0007093387 [Accessed 7 April 2014].
[24] SAUTER, Gus, 2002. Index Rex. Journal of indexes [online]. Available at:
http://www.etf.com/publications/journalofindexes/joi-articles/1411-index-rex.html?fullart=1&start=6
[Accessed 21 February 2014].
[25] Tokyo Stock Exchange, 2014. JPX-Nikkei Index 400 Factsheet. [pdf] Tokyo: Tokyo Stock Exchange.
Available at: http://www.tse.or.jp/english/market/topix/b7gje6000001ns00-att/b7gje6000001rsua.pdf
[Accessed 6 April 2014].
[26] Tokyo Stock Exchange, 2014. Nikkei 225 Exchange Traded Fund. [pdf] Tokyo: Tokyo Stock
Exchange. Available at: http://www.tse.or.jp/english/rules/etfs/list/pamphlet/1321-e.pdf [Accessed 7 April
2014].
[27] Tokyo Stock Exchange, 2012. Tokyo Stock Exchange Index Guidebook. [pdf] Tokyo: Tokyo Stock
Exchange. Available at: http://www.tse.or.jp/english/market/topix/b7gje60000003v3uatt/b7gje60000006cm3.pdf [Accessed 20 December 2013].
47
[28] Tokyo Stock Exchange, 2014. TOPIX Exchange Traded Fund. [pdf] Tokyo: Tokyo Stock Exchange.
Available at: http://www.tse.or.jp/english/rules/etfs/list/pamphlet/1306-e.pdf [Accessed 7 April 2014].
[29] Tokyo Stock Exchange, 2005. TOPIX moves to Free-Float. [pdf] Tokyo: Tokyo Stock Exchange.
Available at: http://www.tse.or.jp/english/market/topix/b7gje60000003v3u-att/pamphlet-e.pdf [Accessed
20 March 2014].
[30] TOPIX and Nikkei225. Tokyo Stock Exchange [online]. Available at:
http://www.tse.or.jp/english/market/topix/comparison.html [Accessed 20 March 2014].
[31] TOPIX Index X-pert Certificate. Deutsche Bank AG [online]. Available at:
https://www.xmarkets.db.com/DE/ENG/Product_Detail/DE0007093379 [Accessed 7 April 2014].
[32] TSE first section issues. Google finance [online]. Available at:
https://www.google.com/finance?q=INDEXTOPIX%3ATOPIX&ei=htlGU6DvD8aDwAPFJA [Accessed
10 April 2014].
[33] TUCHMAN, Mitch, 2013. What is an index fund? Investing basics. Forbes [online]. Available at:
http://www.forbes.com/sites/mitchelltuchman/2013/07/12/what-is-an-index-fund-investing-basics/
[Accessed 28 February 2014].
[34] Unlimited Index Certificate on Nikkei 225. Commerzbank [online]. Available at:
http://www2.warrants.commerzbank.com/Products/ProductDetails.aspx?rp=None&rps=None&c=1077594
&p=139666724&pc=81&dm=NoHeaders&ip=1&pm=Full [Accessed 7 April 2014].
[35] Unlimited Index Certificate on TOPIX. Commerzbank [online]. Available at:
http://www2.warrants.commerzbank.com/Products/ProductDetails.aspx?rp=None&rps=None&c=1077594
&p=139666716&pc=81&dm=NoHeaders&ip=1&pm=Full [Accessed 7 April 2014].
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[Accessed 22 February 2014].
[37] What are ETFs. Nasdaq [online]. Available at: http://www.nasdaq.com/investing/etfs/what-areETFs.aspx [Accessed 21 February 2014].
48
List of graphs
Graph 1:
Nikkei Stock Average’s evolution since creation
21
Graph 2:
TOPIX’s evolution since creation
23
Graph 3:
Nikkei 225’s relative performance versus TOPIX (2005-2014)
27
Graph 4:
Worldwide ETF Growth
37
List of tables
Table 1:
Sector allocation comparison
25
Table 2:
Comparison of Nikkei 225 and TOPIX Summary
28
Table 3:
The difference between Active and Index Fund investment strategies
34
Table 4:
Index certificates’ costs
36
Table 5:
Comparison of Features of Index Products
40
Table 6:
Nikkei Licenced Exchanges and ETF Providers
41
Table 7:
Nikkei and TOPIX certificate comparison
42
Table 8:
Nikkei and TOPIX Exchange-Traded Funds comparison
43
List of pictures
Picture 1:
Nikkei Licencees
41
49
List of annexes
Annex A
Indices calculated by TSE
Annex B
Indices calculated by Nikkei Inc.
Annex C
Current Nikkei Stock Average components by sector
Annex D
Current TOPIX sector classification
50
Annex A
Indices calculated by TSE
Source: Tokyo Stock Exchange, <http://www.tse.or.jp/english/market/topix/index.html >, retrieved on 20.03.2014
51
Annex B
Indices calculated by Nikkei Inc.
1) Nikkei Stock Average & Derived Indexes
-
Nikkei Stock Average
-
Total Return Index
a) Nikkei 225 Total Return Index
-
Nikkei Stock Average Strategy Index Series
a) Nikkei 225 Covered Call Index
b) Nikkei 225 Risk Control Index
c) Nikkei 225 Leveraged Index
d) Nikkei 225 Inverse Index
-
Volatility Index
a) Nikkei Stock Average Volatility Index
b) Nikkei 225 VI Futures Index
-
Dividend Point Index
a) Nikkei Stock Average Dividend Point Index
2) Other Stock Indexes
-
JPX-Nikkei Index 400
-
Theme Index
a) Nikkei China Related Stock 50
-
Benchmark Index
a) Nikkei Stock Index 300
b) Nikkei 500 Stock Average
c) Nikkei JAPAN 1000
d) Nikkei JASDAQ Stock Average
e) Nikkei All Stock Index
3) Bond Index
-
Nikkei JGB Index
-
Nikkei Bond Index
4) Commodity Index
-
Nikkei Commodity Index
-
Nikkei Commodities Futures Index
-
Nikkei-TOCOM Commodity Index
-
Nikkei-TOCOM Leveraged Index
52
-
Nikkei-TOCOM Inverse Index
5) Other Index
-
Nikkei Currency Index
-
Nikkei Business Index
-
Nikkei Business Climate index
Source: Nikkei Indexes, <http://indexes.nikkei.co.jp/en/nkave/index >, retrieved on 20.03.2014
53
Annex C
Current Nikkei Stock Average components by sector
Sector
Total number of companies
in the sector
Technology
57
Financials
21
Consumer goods
28
Materials
64
Capital goods/
Others
35
Transportation
and utilities
20
Subsector
Pharmaceuticals
Electric machinery
Automobiles & Auto parts
Precision Instruments
Communications
Banking
Securities
Other financial services
Insurance
Fishery
Retail
Foods
Services
Mining
Pulp & Paper
Petroleum
Glass & Ceramics
Nonferrous metals
Textiles & Apparel
Chemicals
Rubber
Steel
Trading companies
Construction
Shipbuilding
Other manufacturing
Machinery
Transport equipment
Real estate
Railway & bus
Marine transport
Warehousing
Gas
Land transport
Air transport
Electric power
Number of
companies
8
29
9
5
6
11
3
1
6
2
8
11
7
1
3
2
9
12
5
18
2
5
7
8
2
3
16
0
6
8
3
1
2
2
1
3
Source: Author, based on data provided by Nikkei Indexes,
<http://indexes.nikkei.co.jp/en/nkave/index/component?idx=nk225#29>, retrieved on 20.03.2014
54
Annex D
Current TOPIX sector classification
Category
Constituents (sectors)
Foods
Fishery, Agriculture and Forestry; Foods
Energy resources
Mining; Oil and coal products
Construction and materials
Construction; Metal products; Glass and ceramics products
Raw materials and chemicals
Textiles and apparels; Pulp and paper; Chemicals
Pharmaceutical
Pharmaceutical
Automobiles and transportation
Rubber products; Transportation equipment
equipment
Steel and nonferrous metals
Iron and steel; Nonferrous metals
Machinery
Machinery
Electric appliances and precision
Electric appliances; Precision instruments
instruments
IT and services, others
Other products; Information and communication; Services
Electric power and gas
Electric power and gas
Transportation and logistics
Land transportation; Marine transportation; Air transportation,
Warehousing and harbor transportation service
Commercial and wholesale trade
Wholesale trade
Retail trade
Retail trade
Banks
Banks
Financials (ex banks)
Securities and commodities futures; Insurance; Other financial
business
Real estate
Real estate
Source: Author, based on data provided by Tokyo Stock Exchange, <http://www.tse.or.jp/english/market/topix/index.html>,
retrieved on 20.03.2014
55

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