According to legend, Groucho Marx resigned from the Friar's Club in disgust at a club that would accept him as a member. Facing the high honour of re-entering the best of Japan's stock index may be wishing it could do the same. When the JPX 400 index first launched in January 2014, it was by far the shiniest toy in the Abenomics box. A benchmark conjured from pure optimism to promote the ideals of corporate value creation, efficient capital use, and corporate governance improvement. Its constituents would be heroes. It's trackers would be richly rewarded. It rejects would cringe in shame. Its very existence, ran the propaganda, was proof that Japan was changing.
Its flaws were soon apparent. even as an estimated $4 trillion yen of passive money began to pour in, the angelic intentions with which it was built could not offset the effects of filtering companies by return on equity, operating profit, market cap, and a set of predictable qualitative criteria relating to good governance. It was inherently prone, says Travis Lundy writing in Smartkarma, to large numbers of member changes every year, to front running of those changes, and to buying high and selling low. Instead of glinting with smart beta, it has actually underperformed the topics by around 2.2% since its launch.
The JPX 400's very first act of righteous blackballing in 2014 illustrates the problem. In August that year, just seven months out of the blocks, the index decided that Sony, then trading around 1990 yen per share, no longer met the club rules. Since that exclusion, Sony stock has risen 121% while JPX 400 has plotted up just 24%. Similarly, eye-catching outperformance awaited Konami and Bic Camera when they left the fold.
All three of those companies, however, have now recovered the necessary status to rejoin the index, along with 28 other fairly expensive names to be included at this year's rebalancing. On that evidence, investors may find it more interesting to look at the companies now being booted out. The alternative would be to adjust the construction methodology of the APK 400. As Groucho Marx also said, "These are my principles. And if you don't like them, I have others.